Will Costco's trailing twelve-month gross margin fall below 12.5% by end of FY2026?

The 3-year expansion trend (12.26% to 12.85%) is strong and the 35bps buffer, while thin, is supported by improving cost dynamics (merchandise costs +7.9% vs revenue +8.2%). LIFO charges were $173M in FY2025 but stabilized to a $1.9M credit in Q1 FY2026 -- this stabilization is critical, suggesting the worst tariff impact may have already been absorbed. The TTM measure is forgiving: even if one quarter dips, the other three quarters at 12.85%+ would buffer the TTM average. Section 122 tariffs are limited to 150 days and mitigation strategies are active. For TTM to breach 12.5%, sustained compression across multiple quarters or a catastrophic single quarter is needed -- unlikely given current trajectory.

The unresolved debate about tariff pass-through capacity is the key uncertainty. $63B of imports at 10-15% tariff implies $6.3-9.5B in additional costs, but even partial absorption would be significant relative to Costco's ~$33B gross profit. However, management's 'offensive approach' and LIFO stabilization in Q1 FY2026 suggest adaptation is working. The Stress Scanner models 75-125bp expected compression but over multiple years, not a single fiscal year. The TTM metric requires average compression across all 4 quarters -- harder to breach than a single-quarter metric. Base case is TTM gross margin stays above 12.5%, but the tariff uncertainty and thin buffer warrant slightly higher probability than a pure trend extrapolation would suggest.

Base rate analysis: gross margin expanded every year for 3 consecutive years despite $173M in LIFO charges in FY2025. The expansion CONTINUED through the tariff shock period, demonstrating resilience. Q1 FY2026 showed a $1.9M LIFO credit, suggesting normalization rather than escalation. Section 122 tariffs are temporary (150-day limit). Even the Stress Scanner's expected case (75-125bp compression) is modeled over multiple years, not concentrated in FY2026. For FY2026 specifically, one year of tariff impact is unlikely to overcome the positive trajectory, especially with active mitigation (country-of-origin shifts, KS domestic sourcing, global buying consolidation). The margin would need to drop 35bps from a rising trend -- requires a significant reversal.

The data strongly favors NO. Gross margin expanded 59bps over 3 years and the trend is clearly upward. LIFO charges of $173M in FY2025 were insufficient to reverse the expansion -- margin STILL went from 12.63% to 12.85%. Q1 FY2026 shows LIFO stabilization with a $1.9M credit. The TTM metric is a high bar: all four quarters would need to show material compression for the average to drop 35bps. Merchandise costs growing slower than revenue (+7.9% vs +8.2%) demonstrates structural improvement in buying power. Management is actively mitigating tariffs with multiple strategies. The 35bps buffer looks thin in isolation but the expanding trajectory means the buffer is likely growing, not shrinking.

The key risk window is Q2-Q4 FY2026, where tariff impact first materializes. Q1 is already clean (LIFO credit). For TTM to drop below 12.5%, Q2-Q4 quarters would need to average below approximately 12.4% gross margin to drag the TTM down, given Q1 is likely at or above 12.85%. That requires roughly 45bps average compression in 3 quarters -- plausible under severe tariff escalation but not the base case given LIFO stabilization and active mitigation. The Stress Scanner's 75-125bp expected case over multiple years suggests FY2026 alone would see perhaps 25-50bp compression at most. With the starting point at 12.85%, that lands at 12.35-12.60% -- straddling the threshold. The uncertainty is real but the trend favors staying above.

Quantitative analysis: TTM gross margin at 12.85% on ~$270B revenue implies ~$34.7B gross profit. For TTM to fall to 12.49%, gross profit would need to decline by ~$1.0B relative to the 12.85% trajectory. FY2025 LIFO charges were $173M total -- nowhere near the ~$1B magnitude needed to breach the threshold. Even if LIFO charges doubled to $346M, that would compress margin by roughly 13bps to 12.72% -- still well above 12.5%. The pass-through risk is real but Costco's buying power (largest membership warehouse operator globally) and active mitigation strategies make full cost absorption unlikely. This is a low-probability outcome requiring a scenario well beyond what the committee's analysis supports.

3-year expansion trend (12.26% to 12.85%) plus LIFO stabilization in Q1 FY2026 plus active tariff mitigation strategies makes breaching 12.5% unlikely. The 35bps buffer is thin but the trend direction is upward. TTM metric is harder to breach than single-quarter. Management's 'offensive approach' to tariffs and multiple mitigation levers (country shifts, KS sourcing, assortment rotation) provide resilience.

LIFO charges in FY2025 ($173M) didn't prevent margin expansion from 12.63% to 12.85%. Q1 FY2026 shows a LIFO credit ($1.9M). Section 122 tariffs capped at 150 days. Management proactively mitigating. Merchandise costs growing slower than revenue. TTM requires sustained compression. The math doesn't support breaching 12.5% in a single fiscal year given the starting position and trend momentum.

While the trend is positive, the 35bps buffer is thin and the full tariff impact hasn't materialized yet -- it first appears in Q2 FY2026 (March 2026 earnings). Data staleness is 174 days. If tariffs escalate beyond 15% or new tariffs are imposed on additional categories, margin compression could be more severe than the committee modeled. The pass-through debate is genuinely unresolved. However, the base case remains that mitigation strategies hold and the TTM stays above 12.5%.