Costco

Costco's fiscal third-quarter results featured an 11.6% increase in revenue and diluted EPS of $4.93, up 15.3%. Comparable store sales (excluding fuel) rose 6.6% and membership fee income grew 10.7%, but gross margin fell 21 basis points to 12.8% as fuel sales and discounts squeezed profits.

Why it matters: We believe Costco's widening pricing authority and unparalleled member loyalty (near 90% global renewal rate) reinforce its dominance. However, the results illustrate that maintaining its leadership requires tactical margin sacrifices amid shifting consumer behavior. Global traffic rose 2.4%, but core merchandise gross margin fell 9 basis points from price cuts on beef and eggs. We view this aggressive posture as a reasonable offensive play that reinforces Costco's value proposition even if it creates near-term volatility for merchandise profits. Digital-enabled comparable sales rose 21.5%, driven by personalized product recommendations that secured $500 million in online sales and tripled standard conversion rates. In our view, deepening digital member engagement is a high-return lever that expands long-term loyalty.

The bottom line: We raise our fair value estimate for wide-moat Costco to $740 from $650, primarily reflecting a lower cost of capital under our updated framework. We view shares as roughly 35% overvalued and believe the share price implies unrealistic EPS growth expectations. Under our updated discount-rate framework, we lowered our cost of capital estimate to 7% from 7.4%. The change does not reflect a new view of Costco's business, but rather, a more refined expression of our existing risk assessment. We surmise that the market is pricing in permanent, midteens earnings growth, which we view as overly optimistic amid intense competition. As domestic warehouse growth naturally matures, compounding returns will depend on international replication where entry barriers vary.

We have raised our fair value estimate for Costco to $740 per share from $650, primarily reflecting a lower cost of capital estimate under our updated discount-rate framework. Under this updated framework, we lowered the weighted average cost of capital estimate to 7% from 7.4%. This change does not reflect a new view of Costco's business, but rather a more refined expression of our existing risk assessment.

Costco US remains the primary earnings driver, representing about 73% of consolidated revenue and, together with Canada, roughly 84% of operating income. We forecast gross US revenue to expand at a 7.2% CAGR, driven by average traffic and ticket growth of 4.1% and 1.2%, respectively, steady warehouse expansion of about 16 units annually, and continued growth in executive memberships. We believe Costco will continue to gain market share in the US by reinforcing its price leadership and membership loyalty, driven by deep vendor relationships, disciplined cost controls, and a curated merchandise mix that consistently delivers value. Canada should see mid-single-digit sales growth, further building upon its strong segment-level efficiency.

We estimate Costco international growth at a 9.9% CAGR, reflecting an average of 12 new stores per year in markets such as South Korea, Japan, Mexico, and Taiwan. These regions are expected to accelerate their profit contribution, with international overtaking Canada to represent nearly 20% of operating income by the end of our forecast (up from 16% currently). Early successes abroad highlight the adaptability and profitability of the warehouse club model, with disciplined site selection, strong customer reception, and rising global renewal rates, making international Costco’s clearest long-term growth lever.

Membership income is a critical underpinning of our valuation. We project total memberships to reach over 135 million by the end of the forecast period. With renewal rates hovering around 90% and executive membership penetration climbing, we anticipate membership fee income to nearly double, providing a recurring, high-margin income stream that underwrites reinvestment in price leadership while maintaining profitability.

By bringing these pillars together, we project that consolidated revenue will compound at 7.4%. After year five, growth should tilt more heavily toward international as the US footprint approaches saturation. Finally, we model operating margins to rise from 3.8% in fiscal 2025 to 4.9% by the end of the explicit forecast, driven by membership growth, SG&A leverage, and greater private-label contribution.

We assign Costco a Morningstar Economic Moat Rating of wide, underpinned by its cost advantage and intangible assets, both of which are reinforced by the firm’s membership-driven business model, operational discipline, and brand trust. Over the past five years, Costco has generated an average return on invested capital of 24.6%, well above our 7% estimate of its cost of capital, and we expect these returns to persist for at least two decades.

Costco’s cost advantage stems from three structural efficiencies: scale, merchandising discipline, and minimal overhead. Costco is one of the largest global retailers, providing it with tremendous purchasing leverage. Its limited stock-keeping units—offering only about 4,000 SKUs in its warehouses versus 100,000 or more at traditional grocers—support a more streamlined supply chain procurement process and yield lower per-unit costs, which are passed directly to members, especially on grocery goods, where select items deliver over 30% in per-ounce savings versus major supermarkets. With over $275 billion in sales and a commanding 60% share of the US warehouse club market, according to Euromonitor, Costco can purchase merchandise in bulk at favorable terms and spread fixed costs (distribution, administrative, and IT) over a large sales base. Its operating model—high volume per SKU, cross-docking distribution, minimal inventory handling, membership fee-based model, and no costly store fixtures or advertising—yields industry-low operating expenses with selling, general, and administrative expenses representing 9% of sales versus roughly 20% at Walmart and Target. As a result, Costco can profitably sell products at prices that competitors with higher costs cannot match. This pricing power is a formidable moat source in retail.

Complementing its cost edge, Costco has also built a strong brand known for quality and absolute low prices, earning deep trust from club members. The membership model itself creates a sense of exclusivity and loyalty, where members feel invested and shop to maximize the value of their annual fee. Costco’s brand equity is evident in its roughly 90% membership renewal rate, which has held steady over the years regardless of the economic backdrop. The company’s refusal to mark up products beyond a fixed modest margin and its famous loss-leaders (like the $1.50 hot dog or $4.99 rotisserie chicken, which Costco famously maintains even at financial loss) reinforce its intangible assets: a brand reputation for putting customer value first. Moreover, Costco’s “no frills," treasure-hunt shopping experience creates customer enthusiasm that traditional retailers struggle to achieve.

Costco’s brand and cost advantages reinforce each other. Its trusted brand draws more members and sales volume, which increases scale and lowers unit costs, allowing even lower prices that further enhance the brand’s value promise. This self-reinforcing cycle is a hallmark of Costco’s wide moat. This can also be seen in the company’s private-label offering, Kirkland Signature, which comprises almost 33% of net sales, providing higher margins for Costco while reinforcing the value proposition for customers.

Costco’s competitive dominance is exemplified by its sales per square foot of over $2,000, which is more than double that of Walmart and nearly 5 times as much as Target. In our view, its US operations (more than 70% of sales) benefit from decades of infrastructure development, vendor relationships, and real estate scale. Inventory turns remain best in class at about 30 days compared with Walmart’s 40 days and Target’s 61 days. Even compared with its closest competitor, Costco is far more profitable ($77 in EBIT per square foot versus $26 at Sam’s Club); Sam’s Club (33% share of the warehouse club market) boasts sales per square foot of just $1,150, despite launching in the same year as Costco and operating a similar size store base in the US (Costco 629, Sam’s Club 600). We attribute this differential partly to the fact that Costco caters to a more affluent customer base, with an average household income of around $125,000 versus just $80,000 at Sam’s Club. Given that buying in bulk tends to come with a higher absolute price tag, shopping in a warehouse club is more tenable for higher-income shoppers. Additionally, Costco’s membership base continues to climb steadily, and members per warehouse have been increasing over time. Based on our estimates, members per warehouse averaged over 87,000 in the past fiscal year, up from around 59,000 in 2010. Growing members per location indicates that Costco is deepening its penetration and loyalty in markets over time, rather than cannibalizing its footprint, which suggests durability in its competitive edge and further spreads fixed costs over a larger member base.

In Canada (just a midteens percentage of revenue), Costco’s position is even greater, as it faces less direct competition and often commands higher average transaction values with roughly $2,352 and $116 in sales and EBIT per square foot, respectively. Despite higher wage pressures and regional cost variance, we posit Costco Canada remains the company’s strongest segment with efficient store-level operations and limited geographic sprawl.

Internationally, we estimate that Costco’s ROIC has been rising over the last decade (averaging 16%) and that this trend will likely continue. Costco’s international success has primarily been the result of carefully selecting new markets to enter and differentiating itself from existing retailers, allowing it to attract customers with little direct warehouse club competition. Globally, Costco has 53% market share in the warehouse club industry, including 65% share in South Korea, 25% in Mexico (behind Sam’s Club’s 72%), and captures the entire market in Japan, Australia, France, and the United Kingdom. Management has stated plans to allocate more of its new-store openings to international markets in the coming years, and we believe its historical success indicates the company has a unique ability to tailor its product offerings to consumer preferences across countries.

Overall, Costco’s wide moat is rooted in its structural cost advantages and powerful intangible assets, both of which are magnified by the firm’s membership-driven model and operational rigor. Its US and Canadian operations are firmly entrenched as moat-bearing in mature markets, and international operations offer additional promise for growth and continued long-term economic value creation as the company continues to expand its reach globally.

With moat-bearing attributes across each of its segments, minimal promotional expense, best-in-class customer retention, and a growing global presence, Costco is one of the few retailers positioned to thrive amid supply chain complexity and rising cost pressures. We believe its scale, loyalty economics, and private-label strength will reinforce its ability to deliver excess economic returns for at least the next 20 years.

Executive membership penetration continues to rise (11% higher than a decade ago), lifting the profitability of Costco’s recurring fee base and merchandise sales, as these members spend 3 times more on average than a basic member.

Kirkland Signature’s 33% sales penetration strengthens Costco’s brand equity while providing margin accretion in staple categories.

International warehouses in South Korea and Taiwan are producing among the chain’s highest sales volumes, suggesting durable global demand and that its brand power is resonating across borders.

Expansion into markets with stricter labor laws and zoning restrictions, such as parts of Europe, could slow Costco’s growing footprint and ability to further replicate its US model.

A decline in membership renewal rates (amid constrained consumer spending), currently around 90%, could weaken Costco’s most durable profit engine and its ability to reinvest in prices without impairing operating margins.

Digital sales remain at 7% of revenue, and continued underinvestment in e-commerce and last-mile fulfillment could cause Costco to lag peers in higher-margin discretionary categories.