Key Points:
- Costco reported solid top-line results that matched Advan’s observed metrics.
- As we’ve seen across retail, Costco’s traffic began to decelerate in April as we moved to the backside of tax refunds and as gas prices became viewed as “higher-for-longer.” Weather and a difficult comp also weighed.
- The stock fell (-3.9%) because membership growth slowed, management spoke of price rollbacks to demonstrate greater value to members, and management (our read) also suggested a softer May.
- Our analysis suggests that membership growth has slowed in the US due to: (1) its new store opening program in 2024 being more infill and (2) flat-to-down population growth in California (its #1 market).
Based upon our reading of sell-side notes on Costco’s FQ3 results and the Q&A there are three concerns that hit the stock (-4%), one, CFO Gary Millerchip’s comments on the consumer suggested a softer May (to be reported next week), two, a move to cut prices on key items in order to demonstrate more “price authority,” (which follows similar comments from BJs), and three, the deceleration in new member sign-ups (+4.1% YoY vs. F’25’s +6.3%).
Taking them in order: CFO Gary Millerchip said, “We will release [May] sales next week, so I won't get into any sort of short-term trends. But I'll maybe just bridge back to a couple of comments I made earlier. We're generally really not seeing any major change in our members' behavior… I'll caveat that with gas, of course. Gas prices are very much on members' minds and they've had a major impact on our overall growth in gas and have also, for sure, become a bigger percentage of a member's total spend in the month because of the higher prices of gas that are in the market today. We've widened our gaps in terms of price to make sure we're there for our members, but we know that's something that's very high on our members' minds.” As the chart shows, there was a meaningful surge in traffic during April, the 1H of May experienced an air pocket following the surge.
Second on the price cuts, CEO Ron Varhais said, “Against the backdrop of ongoing macro uncertainty, our focus is providing quality goods and services at the lowest possible price continues to resonate strongly with our members... We're closely monitoring the longer-term inflationary impacts of higher oil prices as well as the future impacts of tariffs. Our buyers continue to demonstrate their ability to adapt and are using their significant experience and expertise to try to reduce the impact on prices for our members. Our goal is to be the first to lower prices and the last to raise them... We're also able to bring greater value to our members through many exciting new Kirkland Signature items…” This followed similar comments from BJs and press stories that new Kroger CEO Greg Foran intends to significantly cut prices to improve Kroger’s value position (in response to market share gains by club, Aldi, TJ, Walmart, etc.). As such, expectations for Costco’s forward merchandise margin rate settled lower. (We remind readers that Costco has an 11.1% merchandise margin vs. Kroger’s 23%.)
Third, on the slower membership growth, management pointed to a shift in the international openings to more infill and the absence of any new large international market / regions. Management also noted that it’s lapping some large comps. However, the 3-year CAGRs have also slowed in the past two quarters, and so the latter is an incomplete answer. We believe that there’s also been a slowdown in the US due to 2024’s openings being heavily infill (68%) per our analysis. (As a reminder, membership fee income represents ~50% of operating income.)
Using Advan+Claude, we can see the impact of infill in the first panel below, with the class of 2024 weaker than 2023 and 2025. California and Texas received the most net new locations over the past two years at 8 each, out of 39 in total (US only). The second panel shows that the Texas locations have performed well, whereas those in California lagged. Costco started 2024 with only 38 locations in Texas (834K residents per location). By contrast, it had 135 locations in California at the start of 2024 (293K residents per, or 3X more concentrated than Texas). In California, 5 of the 8 were infill with a pre-existing Costco within six miles (ish).
Separately, California is Costco’s largest market, with 30% of its stores and a larger share of sales, per Advan’s SpendViewTM data. California’s population growth is expected to be flat to down for 2026, and that sluggishness, and other recent discombobulations, will be a headwind to Costco’s membership growth.
To conclude, we suspect that the softer pace of membership growth reflects the store infills (fewer new members per added store) and no population growth in its biggest market; combined, that suggests continued modest membership growth over the next few quarters (even years), unless Costco introduces a meaningful innovation and / or steps up its new members marketing spend, along with more effective targeting.
Lastly, for those keeping score, Costco reported a +6.8% comp-sales increase for FQ3 (US, excluding gas), with ticket contributing around +420bps and comp-traffic, +260bps. Advan observed traffic increased +3.2% on a comp-adjusted basis, i.e. we’re close to the +260bps.
