Here's what impressed us most about Costco's earnings beat in a tariff-filled world

CNBC

29-05-2025

Costco on Thursday returned to its old ways of delivering earnings beats. Despite concerns about a tariff-driven hit to margins, the retailer's better-than-expected results showed it is prepared to handle whatever challenges it may face. Total revenue in its third quarter of fiscal year 2025 increased 8% year over year to $63.2 billion, topping Wall Street expectations of $63.19 billion, according to estimates compiled by LSEG. Earnings per share (EPS) in the 12 weeks ended May 11 came in at $4.28, beating the consensus of $4.24, LSEG data showed. Shares of Costco were slightly lower in extended trading Thursday, along with U.S. equity futures more generally. Bottom line Costco turned it around this quarter after a surprising EPS miss the last time it reported. Because Costco reports its sales on a monthly basis, its topline figures are pretty well understood by the market when it comes time to report. What isn't known is profitability metrics. That's why we were pleased to see both Costco's gross margin and operating margin top Wall Street expectations, rising 41 basis points and 25 basis points, respectively, on an annual basis. A basis point is equal to 0.01 percentage point. Costco doesn't rely on raising prices to boost profits. It's the company's philosophy to only raise prices as a last resort. Instead, it focuses on keeping prices low, delivering greater value to its members, and driving higher sales volumes while efficiently managing costs—making its strong results even more impressive. Why we own it Costco is the best-run retailer in the world, with a business model focused on offering its members a relatively small universe of products at hard-to-beat prices. Costco has succeeded for decades, but the high inflation of recent years has made the company's value-focused ethos really shine. Competitors: BJ's Wholesale , Walmart , fellow Club holding Amazon Last buy: June 15, 2020 Initiation date: Jan. 27, 2020 One analyst remarked on the earnings call that the company has increased its operating margin — also referred to as earnings before interest and taxes (EBIT) margin — on a year-over-year basis for the eighth or ninth quarter in a row. By our count, it is eight — with its February 2023 quarter being the last time operating margin contracted compared with the year-ago period. Regardless, the analyst's overarching point holds true: That's an impressive streak for a retailer obsessed with providing customers value like Costco. We were even more impressed by how Costco improved its margins during a period when many retailers scrambled to figure out how to navigate President Donald Trump's higher tariffs on goods entering the U.S.. This is where Costco's size, global scale and limited product offerings really shines. The company said it rerouted goods sourced from countries with high tariff rates to non-U.S. markets, . And for the U.S., it pulled forward items it had planned for the summer and increased locally produced goods to reduce tariff impact. If other retailers are out of stock early this summer because they could not afford to pay the tariff, it means more opportunities for Costco to gain share. Another way Costco is mitigating the impact of tariffs is by moving more sourcing for its in-house Kirkland Signature products into the countries or regions where the item is sold. Notably, sales of Kirkland Signature items outpaced Costco's overall sales growth in the quarter. As we highlighted in a feature story in March , Kirkland Signature products tend to carry a higher margin than branded items, and the label's overall popularity has been key to Costco's success. Costco's quarter had a lot to like from it. The consistent sales growth, slow but steady margin improvement, and the ability to navigate tariffs are as good, if not better, than any retailer. That's why the stock is up about 10% year to date, outpacing Walmart's 7% rise and the flat S & P 500. However, we are reiterating our 2 rating, meaning we'll wait for a pullback before buying more. Our only hesitation here is the stock's lofty price-to-earnings valuation. We are reiterating our price target of $1,100 a share. Quarterly commentary Total comparable sales, an important retail industry metric, increased 5.7% in the quarter and 8% on an adjusted basis, which strips out changes from gasoline prices and foreign exchange. By category, both fresh and non-foods comp sales increased in the high-single digits. Some outperforming non-food categories were gold and jewelry, majors (large ticket items), toys, housewares, and home furnishing. As mentioned, gross margins improved 41 basis points versus the year-ago period to 11.25%, exceeding expectations of 10.92%. Core merchandise was the largest driver of the year-over-year gross margin improvement. It increased by 36 basis points, driven higher sales in its fresh department and declines in some key commodity and ingredient costs, such as dairy, butter, and eggs. Costco's food and sundries category margin — home to dry groceries, items in coolers and freezers, and liquor, among others — also saw margin improvements in the quarter. There was a 30 basis point improvement from Costco's ancillary and other businesses, which include pharmacy, food courts, and travel. Gas and e-commerce were the main drivers of the increase. Costco saw a slight margin headwind related to a one-time vacation accrual impact from a new employee agreement effective in March. LIFO (last in, first out) accounting also had a negative impact on gross margins. The company said it is calculated by comparing the net landed cost of inventory at the beginning of the fiscal year with the net landed cost of inventory on hand at the end of the current period. In this way, LIFO accounting can be a headwind to margins when prices are rising. Costco has been warning that renewal rates could have a little more variability to them relative to company history due to a couple of factors. One is an increase in digital sign-ups, which tend to renew at a lower rate. The second is store openings in Asia, which usually have outsized membership sign-ups at first but have a lower renewal rate. That played out in the quarter, with the worldwide rate and the U.S. and Canada rate declining to 90.2% and 92.7%, respectively, from 90.5% and 93% in the prior quarter. The company said the primary driver of the decline was from a Groupon promotion in the fall of 2023. Although digital sign-ups renewal at a lower rate, the company will gladly take the new members every day, especially because digital tends to skew toward younger members. The direction of total paid membership continued to move in the right direction, increasing to 79.6 million at the end of the quarter, up 6.8% year over year, and up from 78.4 million in the prior quarter. To be sure, that still missed Wall Street expectations by about 100,000. We are hardly concerned about the decline in renewal rates or the paid membership miss. Costco's comparable traffic — which measures the number of customers shopping in its warehouses — increased 5.2% year over year, a figure that is the envy of all retail. Costco estimates it will end the fiscal year with 914 stores, 24 more than at the end of fiscal 2024 but one less store than it anticipated three months ago. (Jim Cramer's Charitable Trust is long COST. See here for a full list of the stocks.) 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