Costco Falls on Concerns Over Membership Renewals, Margins

(Bloomberg) -- Costco Wholesale Corp.'s better-than-projected results still weren't enough to please investors, who instead zeroed in on a drop in membership renewal rates and narrowed margins.

The shares fell as much as 5.9 percent, the most in more than three months, despite the warehouse retailer posting fourth-quarter sales and earnings that topped analysts' estimates. Even as the company's growth rate dwarfs those of many retailers, Costco's margins show it isn't immune to the fierce competition that is ravaging the grocery industry.

“Despite notable positives, questions remain around an increasingly competitive environment and slowing member trends,” Wells Fargo analyst Zachary Fadem said in a research note.

The warehouse club is facing fresh attacks on its business from the world's biggest retail giants. Amazon.com Inc. is integrating its acquisition of upscale grocer Whole Foods, whose shoppers overlap to a large degree with Costco's. Sam's Club, meanwhile, offers web-friendly services like in-store pickup of online orders -- an approach that Costco has thus far not embraced.

Costco's gross margins dropped 15 basis points, or 0.15 percentage point, as shoppers bought more gasoline, which is less profitable. Membership renewal rates declined, although Costco Chief Financial Officer Richard Galanti said it had to do with the company's decision last year to no longer accept American Express -- which affected automatic membership renewals -- and the timing of some membership drives. Costco raised fees on its 90 million members earlier this year.

Online Delivery

The retailer unveiled a new online delivery service for about 500 non-perishable food items that's free when shoppers order more than $75. It also expanded its existing same-day grocery delivery partnership with Instacart, which now covers 1,700 items. Costco has been slow to embrace e-commerce, in contrast with Wal-Mart and others that have aggressively ramped up their online business to meet changing shopping patterns.

With the threat of heightened competition looming, Costco's stock fell as low as $157.22. Issaquah, Washington-based Costco had been up 4.3 percent this year through Thursday's close.

Chuck Grom, an analyst with Gordon Haskett, cited investor concerns stemming from “modest compression” in membership renewal rates and merchandise margins. He still sees the shares rising to a target of $177, since those issues are “transitory in nature rather than structural.”

Other analysts were not as sanguine: “Renewal rates will remain the focus for investors over the next year, given concerns about Amazon, grocery delivery and a recent fee hike,” Dan Binder of Jefferies said in a note.

Costco shrugged off the concerns. “The renewal rates are fine,” Galanti said in a call with analysts Thursday. As for recent price cuts taken by Amazon-owned Whole Foods on popular items like organic avocados and rotisserie chicken, the CFO said, “we don't believe we've seen an impact from it.”

Half of Costco's shoppers are Amazon Prime members, according to researcher Kantar Retail, up from 14 percent five years ago. Including today's decline, Costco's shares have fallen about 12 percent since Amazon announced in mid-June that it was buying the upscale grocery chain.

Other highlights from Thursday's results:

• The chain posted revenue of about $42.3 billion last quarter, topping the $41.6 billion projected by analysts.
• Earnings amounted to $2.08 a share in the quarter. Analysts had predicted $2.02 a share, according to data compiled by Bloomberg.
• September comparable-store sales rose 8.9 percent, beating analysts' estimates.

To contact the reporter on this story: Matthew Boyle in New York at mboyle20@bloomberg.net.

To contact the editors responsible for this story: Caroline Salas Gage at csalas1@bloomberg.net, Nick Turner at nturner7@bloomberg.net, Jonathan Roeder, Mark Schoifet