Costco (Minutes): No significant inflation observed currently, but be wary of tariff impacts

The following is $Costco Wholesale(COST.US) 2QF25 conference call minutes. For financial report commentary, please see Is the US stock market changing dramatically? But Costco is "rock solid" .

1. Core Financial Information Review

1. Profit Performance: In the second quarter of fiscal year 2025, net income was $1.788 billion, with diluted earnings per share of $4.02, higher than $1.743 billion and $3.92 per share in the same period last year. Last year's results included a tax benefit of $94 million (or $0.21 per share). Excluding this discrete tax item, both net income and diluted earnings per share grew by 8.4%. Operating profit increased by 12.3% year-on-year, impacted by a $57 million reduction (or $0.13 per share) due to foreign exchange rate changes when converting international net income to USD.

2. Sales Situation: In the second quarter of fiscal year 2025, net sales were $62.53 billion, an increase of 9.1% from $57.33 billion in the same period last year. The company's total comparable sales increased by 6.8% (adjusted to 9.1%), and e-commerce comparable sales grew by 20.9% (adjusted for foreign exchange to 22.2%). Foreign exchange and gasoline price deflation reduced sales by approximately 2.1% and 0.1%, respectively, while global shopper traffic increased by 5.7% (5.6% in the US), and the global average transaction value increased by 1% (2.6% in the US).

Net sales in February were $19.81 billion, an increase of 8.8% from $18.21 billion last year. The company's total comparable sales increased by 6.5% (adjusted to 8.3%), and e-commerce comparable sales grew by 19% (adjusted for foreign exchange to 20.2%).

3. Membership Revenue: Membership fee income was $1.193 billion, an increase of $82 million year-on-year, growing by 7.4%, and by 9.4% after excluding foreign exchange factors. Recent membership fee increases contributed approximately 3% to revenue this quarter, with most of the benefits to be reflected in the next four fiscal quarters due to deferred accounting effects, with the largest impact in the fourth quarter of fiscal year 2025 and the first quarter of fiscal year 2026.

As of the end of the second quarter, the renewal rate for members in the US and Canada was 93%, and globally it was 90.5%. Paid household memberships reached 78.4 million, a year-on-year increase of 6.8%. Paid executive memberships reached 36.9 million, a year-on-year increase of 9.1%, with executive members accounting for 47.1% of paid members and 73.8% of global sales4. Gross Margin: The gross margin in the second quarter report increased by 5 basis points year-on-year, reaching 10.85% (4 basis points increase after excluding gasoline impact). The gross margin of core business increased by 5 basis points (4 basis points increase after excluding gasoline deflation), but the profit margin of core-to-core product sales decreased by 8 basis points, due to supply chain investments and changes in the non-food category mix. The gross margin of auxiliary and other businesses increased by 1 basis point (remained flat after excluding gasoline deflation).

E-commerce performance was strong but offset by declining gasoline profitability. The Last In, First Out (LIFO) method decreased by 1 basis point (remained flat after excluding gasoline deflation), with LIFO credit for this quarter at $12 million, compared to $14 million in the same period last year.

5. SG&A Expenses: The reported SG&A expense rate decreased by 8 basis points year-on-year to 9.06% (9 basis points decrease after adjusting for gasoline deflation). SG&A in the operations segment decreased by 7 basis points (8 basis points decrease after excluding gasoline deflation), benefiting from higher labor productivity and cost control. Central and stock compensation remained flat, while pre-opening expenses decreased by 1 basis point due to fewer new store openings this quarter. The new employee agreement is expected to create a 13 basis point headwind for SG&A starting March 3, but due to a smaller increase in the same period last year, the year-on-year basis point headwind is expected to be in the mid-single digits.

6. Other Financial Items: Interest expenses decreased from $41 million last year to $36 million, while interest income fell from $147 million to $109 million, due to reduced cash balances after the $6.7 billion special dividend in January 2024 and declining interest rates. It is expected that interest rates will remain a headwind for the remainder of this fiscal year, but the phase of year-on-year cash balance decline has passed.

II. Detailed Content of the Earnings Call

2.1 Executive Statements on Core Information

1. Business Expansion Plans:

Warehouse Openings: Only one new warehouse will be opened in the second quarter of fiscal year 2025, but there are large plans for the future. A new store will open in Brentwood, California on March 8, and another in Highland, California on the 9th. Four new stores in the U.S. will open next week, including the store in Salon, Massachusetts on March 12, which will be the 620th Costco store in the U.S. and the 900th globally. It is expected that 28 new stores will be opened in fiscal year 2025, including 3 relocation stores, resulting in a net increase of 25 new buildings.

Service Optimization: This quarter, the operating hours of gas stations in North America have been extended, typically opening 1 hour later than before, with some locations opening earlier to make it more convenient for members to refuel. The new employee agreement effective this week in the U.S. and Canada reflects a commitment to employees, including an immediate increase of $1/hour in the maximum wage standard, with further increases of $1/hour in March 2026 and March 2027, bringing the maximum hourly wage for U.S. service staff to $31.90; the minimum hourly wage was raised by $0.50/hour to $20/hour; the average hourly wage for U.S. and Canadian employees exceeds $31/hour (including bonuses), with most employees at the maximum wage standard based on seniority; new employees can enjoy paid vacation in their first year, and U.S. employees can enjoy six weeks of vacation after 30 years of service2. Sales Influencing Factors

Impact of Exchange Rates and Gas Prices: Same-store sales in Canada increased by 4.6%, growing by 10.5% after adjusting for gas price declines and foreign exchange factors. Other international regions saw same-store sales grow by 1.7%, adjusted growth was 10.3%.

Regional Highlights: The strongest comparable sales were in the Midwest, Northeast, and Los Angeles areas of the United States; among other international regions, Mexico, Taiwan, and South Korea performed best in local currency.

Product Categories: Comparable sales in grocery showed mid-single-digit growth, with the refrigerated, frozen food, and grocery departments performing the strongest; fresh food showed high single-digit growth, with meat and produce departments performing well; non-food categories showed low double-digit growth, with jewelry, gift cards, and home goods departments performing well; ancillary business sales showed low single-digit growth, with pharmacy and optical departments performing best, while gas sales declined in low single digits due to decreased volume.

3. Pricing Strategy and Innovation: Committed to providing value to members, seeking opportunities to lower prices first. This quarter, prices were reduced on items such as KS refined olive oil, KS organic peanut butter, and KS corn chips. Prices were lowered through expanded global local sourcing, such as launching locally produced KS purified water for the Chinese market, saving members over 20%. The Kirkland Signature series continues to innovate, with a redesign of diapers this quarter, improving quality and value by 11%, and new products such as KS potato chips, KS vodka soda, and new KS beer were launched.

4. Performance of Ancillary Businesses: In ancillary businesses, the pharmacy and food service departments performed outstandingly. The food court introduced a new strawberry banana milkshake and will reintroduce the fan-favorite turkey provolone sandwich in the third quarter. Gas comparable sales showed a low single-digit decline due to a slight decrease in average price per gallon.

5. Inflation Situation: Inflation varies significantly across departments, with an overall low single-digit rate. Fresh food categories experienced the highest inflation, influenced by meat and baked goods; grocery inflation was relatively low, with inflation in eggs, cocoa, coffee, cheese, and corn offset by deflation in items like sugar, butter, and flour.

6. Supply Chain and Inventory: The supply chain remains relatively stable, but transportation delivery dates are still less predictable than pre-pandemic levels. The non-food procurement team has actively increased inventory over the past year, supporting sales momentum, with overall sales rates being satisfactory.

7. Application of Technological Tools: The new warehouse tool in the app allows members to view the availability and prices of local warehouse items, with over 43 million visits. However, there is still room for improvement, with hopes to enhance member experience through more relevant targeted messaging and experiences.

8. Areas of Sales Growth: Strong sales of precious metals drove e-commerce growth, with departments such as home decor, small appliances, hardware, and sporting goods showing double-digit year-over-year growth. Costco logistics set records during the holiday season, delivering over 500,000 orders, while expanding market share in large items. Costco Next also set holiday sales records, approaching 100 vendor sites, with a significant increase in average order value this quarter9. Alternative Sources of Income

Credit Card Business: This quarter, improvements were made to the co-branded credit card, offering members an attractive cash back rate with no annual fee. Premium members can increase the cash back rate on most purchases at warehouses and Costco.com from 2% to 4%, and last quarter, the gasoline purchase rewards at Costco gas stations were increased to 5%.

Retail Media Business: Following the launch of off-site retail media activities in the first quarter, multiple similar activities have been conducted with about 10 different partners, with more projects in preparation.

10. Tariff Issues: It is difficult to predict the impact of tariffs, but the team remains flexible, and our goal is to minimize the impact of rising related costs on members. About one-third of U.S. sales come from imports, with less than half of those imports coming from China, Mexico, and Canada. During uncertain times, members tend to place greater value on high-quality goods offered at excellent prices. The team will continue to meet this challenge by leveraging global purchasing power, strong supplier relationships, and innovation.

2.2 Q&A

Q: When egg prices rise, does the willingness of consumers to purchase non-essential or essential goods decrease? The performance does not seem to reflect any impact. Is there a slowdown in sales due to factors such as tariff rebounds?

A: Currently, there has been no significant change in member spending over the past few quarters. Members still focus on quality, value, and new products, and they have a willingness to spend, but they are more cautious in their spending choices. This situation may continue or even worsen with the impacts of inflation and tariffs. At the same time, there has been an increase in food consumption for home dining. In non-food categories, the overall trend remains strong, but growth in consumer electronics and apparel categories has been more moderate; however, Costco has performed better in these categories compared to the industry. The overall trend for fresh products is good, with strong growth in premium meat products, and unit growth for low-cost ground beef, poultry, and pork is even faster. The performance in Canada for February aligns with year-to-date results, and after adjusting for foreign exchange and gasoline factors, same-store sales performed the strongest among the three regional segments, although there has been a slight decline from the trends in the second quarter, the overall results remain strong.

Q: The core and core profit margins slightly declined this quarter. Does this mean that Costco's recent trend of profit margin expansion has ended or at least paused, especially in the face of worsening inflation and tariff challenges?

A: The results of this quarter's core profit margin should not be over-interpreted. Overall, the gross profit margin increased by 4 basis points, with slight improvement while continuing to invest more value for members. The core profit margin decreased by 8 basis points, with slight increases in food and grocery categories and fresh food categories, while non-food categories saw slight declines, influenced by certain category structural changes. One factor contributing to the increase in costs this quarter is the rise in supply chain costs, as the company continues to procure more inventory to address the unpredictability of supply chain timelines and potential tariff risks. From the overall quarterly results, the core profit margin is expected to slightly increase, and the company is capable of continuing to invest and take good care of its members. The company is satisfied with its overall profit margin and its ability to achieve performance while investing for membersQ: In February, core same-store sales growth exceeded 8%. Was there any adverse impact from weather on non-essential goods, or was it only offset in the egg business? What is Costco's stance on tariffs for fresh food from countries like Mexico, and will it pass price increases onto consumers?

A: Extreme weather had a brief impact on the Northeast and Midwest, but recovery was overall quick. Regarding tariffs, the procurement team will work with suppliers to optimize the supply chain to minimize costs and avoid direct price increases. The vertical integration of Kirkland Signature (such as the egg business) can better cope with cost pressures.

Q: If tariffs are imposed on China, Mexico, and Canada, will Costco's strategy emphasize that its products still offer the best value compared to others, or will it more actively seek goods from countries less affected by tariffs?

A: It will be a combination of both. With the flexibility of the "treasure hunt" product display structure, alternative products can be found in many categories. The company's personnel, with a streamlined SKU model, are capable of responding to various situations and have established good cooperative relationships with suppliers. Although the final outcome cannot be predicted, the company's personnel are responsive and ready to address potential situations.

Q: In the February sales results, other international business segments showed a sequential slowdown. Is this related to the Chinese New Year? How do you view the long-term growth prospects of international business?

A: In the short term, especially in the Asian market, the Lunar New Year has some impact. However, since it does not significantly affect the company's overall performance, it was not separately pointed out in the financial report. The trend should be viewed in conjunction with data from January and February. In the long term, there is considerable growth potential for international business. The company plans to open 25-30 new stores each year, with slightly more than half likely to be located in the U.S. and slightly less than half distributed in international markets, including Canada, Mexico, Asia, and Europe. These markets have significant growth potential, are not yet fully saturated, and the sales profit margins in international markets are comparable to those in the U.S., and in some cases even better, making it an important part of the company's growth strategy.

Q: How is the performance of the consumer electronics category? How effective are digital promotions (multi-vendor mail)?

A: In the consumer electronics sector, the company's market share is growing, but overall growth is slow. Compared to the overall market downturn, the company is showing flat to slight growth and is still waiting for the next wave of innovation to drive additional growth in this category. During the holiday season, sales of large-sized TVs (98 inches and 100 inches) were good. Regarding international products, the company is excited about this opportunity. In monthly budget meetings, operators from various regions share popular product cases in their markets, and through inter-team experience sharing, the company can better introduce global procurement resources to provide members with more cost-effective products.

This area has already achieved significant growth and will continue to be an important part of the company's sustained growth. In terms of multi-vendor mail and promotional activities, the product mix is exciting, ensuring everyday low-priced items so that members can purchase key products at stable prices, while also collaborating with suppliers to introduce new products and promotions to drive sales. This activity can attract foot traffic, creating a win-win situation for members, and maintaining freshness is key to its successQ: How does Kirkland Signature (KS) compare to national brands in terms of new product introduction? In non-food categories where KS penetration is low, what breakthrough opportunities exist? What is the proportion of KS new products that ultimately become fixed items in the product mix?

A: The biggest opportunity lies in non-food categories. Although brand loyalty in non-food categories is extremely high, the company has made breakthroughs in some categories, such as Kirkland Signature motor oil, which has become the best-selling motor oil in all warehouses, and golf balls, which have successfully entered a category with high brand loyalty. The procurement team evaluates products one by one from a strategic perspective, looking for opportunities to enhance quality or achieve brand quality while providing high cost-effectiveness, rather than blindly developing a large number of KS products. Recently launched sandwich bags and storage bags in the grocery department have been very successful. The success rate of KS products is high, but there are also failures. The company treats KS products and other brand products equally; if sales are poor and members do not recognize them, they will be removed from shelves just like other brand products. The procurement team conducts due diligence to ensure that the KS products launched can bring high value to members.

Q: What is the impact of rising wage costs on profit margins? How can efficiency improvements offset this pressure?

A: Starting this quarter (March), wage costs have increased by about 13 basis points (mainly due to new labor contracts), but through technological optimization (such as entry scanning systems) and process improvements, the SG&A expense ratio has still decreased by 9 basis points. In the future, the company will continue to invest in employee benefits while controlling costs through automation and productivity improvements.

Q: Is the inflation situation such that grocery prices are slightly above 1%, while general merchandise is in a deflationary state?

A: Inflation is highest in fresh categories, especially meat; food and grocery have very low single-digit inflation; non-food categories have recently been in a deflationary state, but as the supply chain deflation situation from a year ago eases, it is now stabilizing. This quarter, there is a certain upward trend in inflation, while last quarter's inflation was zero.

Q: What is the company's strategy regarding media (such as advertising), and how do you view the situation where peers' advertising business accounts for 4% - 5% of digital revenue?

A: The company currently has some additional profit sources, such as co-branded credit card programs, travel business, and e-commerce advertising revenue (reaching hundreds of millions of dollars). The company considers retail media to be an important growth opportunity, but it is currently in the early stages and requires building infrastructure and capabilities. This is not only about creating a retail media platform for CPG suppliers but also about creating personalized experiences for members. This could be a multi-year plan. The company has launched promotional media channels for testing and learning, with 10 activities currently underway and more in preparation. The company does not view this as a new revenue stream with specific profit margins but considers how to reinvest the created value back into members to enhance member loyalty and drive sales.

Q: What measures is the company taking to improve store throughput? What is the purpose of scanning entry data? Can extending gas station operating hours be applied to stores, and will the company consider extending store operating hours?A: Currently, the company is mainly focused on improving checkout speed and the utilization of technology. Scanning data at the entrance is very helpful for operations, allowing employees to understand foot traffic and adjust the opening and closing of checkout counters, thereby increasing productivity. The company is also focused on improving self-checkout, aiming to allow members to pass through quickly and turnover parking spaces. Extending store hours is not out of consideration; the company will continue to monitor this, but there are currently no related plans. The company has 60 gas stations in the U.S. at different stages of expansion, and there is demand from commuters during peak hours, which benefits them.

Q: What is the current scope of the digital promotion (MVM Member Value Mailer)? How many members have received the digital MVM? Will it replace the paper MVM? What gains have been made so far in terms of elasticity or response rates?

A: The preparation process for the printed MVM is lengthy, requiring merchants to prepare two months in advance, but it is still very effective. The digital MVM offers great flexibility; adjustments can be made up until the day before release if suppliers want to join the promotion to drive sales. Buyers will select some products, with the promotion cycle for digital MVM being 10 days, while the regular MVM is about 28 days. The digital MVM also allows more suppliers to participate in communication with members, driving significant sales and serving as an incremental supplement to the paper MVM, which is very effective. About 40 million people will receive information about related activities in their emails. Additionally, the open rate for content about nearby warehouse dynamics in emails is very high, and when members see new products and special offers from suppliers, it is effective for driving traffic. This is also the first attempt to use member data for more targeted communication, rearranging product information based on members' shopping frequency, types of products purchased, etc., making communication more aligned with member needs. Early signs show that member engagement and behavioral changes are encouraging.

Q: How are membership fees in other international countries, and is it time for adjustments? Are there further plans to promote premium membership programs in other international countries?

A: Regarding membership fees, in fiscal year 2023, membership fees were increased in Australia, Mexico adjusted them last September, and recently announced increases in Japan and South Korea. Adjustments to membership fees in various countries are not synchronized but are determined based on their respective plans, the timing of membership fee introduction, and previous adjustments. Future evaluations and adjustments will continue at their own pace. As for premium membership programs, they are typically introduced when a certain scale is reached in individual markets. Currently, there are premium membership programs in several Asian markets, Australia, and the UK. In terms of maturity, Canada and the U.S. have the highest penetration of premium memberships, while Asian markets have significant growth potential and are expected to approach the conversion rates of the U.S. and Canada, with Australia and the UK lagging behind Asian markets. As new and smaller markets open more warehouses, opportunities for introducing premium membership programs will continue to be evaluated.

Q: What is the trend of the average transaction value in the U.S. excluding gasoline? Please elaborate on the impact of product mix, product quantity, and inflation. If the prices of sugar, butter, and flour are falling, why are the prices of baked goods still rising?A: The rise in baked goods prices is mainly due to the impact of rising egg prices outweighing the decline in sugar, butter, and flour prices. In terms of product mix, the situation has been satisfactory over the past 12 months. Over the past two to three years, the frequency of member visits has continued to increase. About a year ago, the overall shopping basket size was flat or slightly declining, but in the past 12 months, due to the growth of non-food items and the provision of high-quality product varieties and cost-effective goods for members, the merchants and operations team successfully reversed the situation, increasing the number of items in the shopping basket and the overall size. Until this quarter, inflation has been relatively stable, and the increase in average transaction value is mainly due to the increase in the number of items in the shopping basket or members purchasing better and larger items, rather than inflation factors. However, this year may see changes due to inflation and potential tariff policies.

Q: What is the reason for the decline in gasoline sales in February?

A: The statement regarding the decline in gasoline sales only pertains to February. From the beginning of the year to date, gasoline sales have shown positive growth, although the growth rate is not large. The overall market may be flat or slightly declining, but the company has been expanding its market share since the beginning of the year. Factors such as weather may affect monthly data, so it is more important to focus on trends over a longer period. Overall, gasoline sales are showing low single-digit growth, which is lower compared to the growth rate of the company's other business segments.

Q: How is the distribution of new stores in new markets versus existing markets, and in the U.S. versus international markets this year?

A: This year, the company plans to open 15 stores in the U.S., 3 stores in Canada, and 7 stores in other international markets, which is a relatively standard scale for store openings for the warehousing business by 2025.

Q: Has extending gas station operating hours resulted in additional gasoline sales, and have customers utilized the extended hours?

A: The company is currently satisfied with member feedback, and the overall usage of gas stations has improved. However, it is still in the early stages, but so far the feedback from members has been very positive.

Q: How does the company's current price gap compare to other merchants, especially in the context of rising inflation?

A: The company views itself as its biggest competitor and holds budget meetings each cycle to review prices, aiming to find ways to reduce costs and prices for members. The company believes its price gap situation is good, and price adjustments are usually proactive rather than reactive to other merchants. If areas needing price adjustments are identified in meetings, the relevant market operations personnel typically make price adjustments before the meetings. The company believes that focusing on providing the best value and quality for members and continuously improving itself is the most important, which is also reflected in the overall value currently offered by the company.

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