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Costco's declining renewal rates create caution among some analysts

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Costco's declining renewal rates create caution among some analysts

From net income to same-store sales, fiscal fourth-quarter results at Costco Wholesale Corp. were above analyst expectations when the company reported Oct. 5.

Yet one figure has caught the attention of some analysts as Costco continues to compete in a grocery industry destabilized by Amazon.com Inc.'s Whole Foods Market Inc.

In its fourth quarter, 90% of Costco's customers in the U.S. and Canada renewed their annual memberships, down from 90.2% in the third quarter. Globally, the renewal rate fell to 87.2% from 87.5% in the previous quarter. Costco requires customers to purchase memberships.

Speaking to analysts during a conference call Oct. 5, CFO, Executive Vice President and Director Richard Galanti attributed the declines in the quarterly rate to automatic membership renewal issues stemming from Costco's June 2016 decision to ditch American Express Co. as its credit card provider in favor of Visa Inc. Galanti also said an increase in membership fees in June has weighed on renewals, adding that the company expects to see renewal rates start growing again within two quarters.

But in research notes published Oct. 6, some analysts said falling renewal rates are likely to continue to worry investors, especially as Amazon makes changes at Whole Foods that favor subscribers to the Seattle-based retailer's Prime membership.

Looking forward to the next two quarters, the percentage of customers who renew their Costco membership "remains a top focus for investors given concerns about the competitive environment and migration to online shopping," Jefferies analyst Daniel Binder wrote in a note.

In an effort to bolster its e-commerce strategy, Costco said during its conference call that it debuted two new grocery delivery services this week, including a same-day service that allows customers to order fresh groceries through Instacart.

BMO Capital Markets analyst Kelly Bania wrote that the lower renewal rates, along with weaker profit margins, "may give investors some pause" in the near future.

Bania wrote that the delivery services could be a turning point for the retailer as it faces greater competition in the grocery industry.

"We see this as a huge positive for Costco given the perception that Costco has been slow with its pace of digital transformation," Bania wrote.

While many analysts indicated that investors will be watching Costco's renewal rates and digital strategy closely in the coming quarters, they also pointed to signs that the Issaquah, Wash.-based company continued sales growth in the month after Amazon cut prices at Whole Foods on Aug. 28.

Costco's same-store sales for September grew 8.9% during its five-week September sales month, higher than the 6.1% the company reported for its entire fourth quarter.

That growth is an indication that Costco already has fared well so far against Amazon, Barclays analyst Karen Short wrote.

"Amazon's recently reduced prices at Whole Foods has not impacted its sales," she wrote.

Shares of Costco were lower in morning trading on the Nasdaq on Oct. 6, falling 6% to $157.05.