Costco switched providers for its reward credit card in June. Image source: Author.

Switching credit cards from longtime provider American Express (NYSE:AXP) to Visa (NYSE:V) has proven to be the right move for Costco (NASDAQ:COST).

The company reported higher-than-expected profits in Q4, partly thanks to it paying lower fees to its new credit card partner versus its previous one. Many analysts had expected bad news from the retailer partly because of problems caused by the switch to Visa and partly because of the changing retail climate.

Instead, the warehouse club delivered earnings of $1.77 a share, up 2% (or $0.04) over last year's Q4 earnings of $1.73 a share. In addition, when factoring out gas sales, the company posted 2% comparable-store sales growth in the United States, 5% growth in Canada, and 1% in the rest of the world, for a total gain of 3%.

Overall the company would have done even better had gas prices been higher.

"Our profits from gasoline during the quarter as compared to last year's fourth quarter were lower by about $27 million pre-tax or $0.04 a share, primarily a function of last year's very strong profit results in the fourth quarter," said CFO Richard Galanti during the earnings call, which was transcribed by Seeking Alpha (registration required).

It's all about the credit card switch

Analysts were expecting poor results from Costco in part because the company's June 20 switch from American Express to Visa was not a simple one. That change was abrupt, with the retailer not only dropping American Express as its rewards partner, but also no longer accepting it at all.

The change brought an enormous amount of media reports on customer dissatisfaction, but it's fair to say the chain and its partner, Citigroup (NYSE:C), handled the conversion as well as could be expected. Early call volumes to Citi were high, but they fell quickly and consumers seemed to adjust well to the new card relatively quickly.

Galanti addressed the conversion during the call.

There was a lot of effort and as you know, there were a few operations glitches during the first few weeks after the cutover. We are now past that and more importantly, the new card is fantastic for our members. In terms of increased cash back rewards, the estimate is about a 40% to 50% improvement in the reward program.

The CFO also noted that the new card should be good for the chain going forward "in terms of driving member value and sales over the next years and of course lowering our effective costs of accepting credit and debit cards," he said.

Galanti also noted that over 1.1 million people have applied for the new card, while over 85% of the accounts transferred from American Express to Visa have been activated. That's in line with the 85% of people who had used the old American Express card in the last 60 days.

Membership stayed strong

Costco ended the year with 86.7 million members, up from 85.5 million at the end of Q3. Galanti said:

In terms of membership renewal rates, we ended the year at 90.3% in the U.S. and Canada. That's ticked down from 90.4% at the end of Q3. In the first half, it was 90.5%; worldwide, 87.6%, which was the same at Q3 end, ticking down from 87.7% in the previous quarter, again, the second quarter.

The CFO noted that U.S. rates were impacted by the credit card switch and that no new signups for the rewards program had been taken for nine months previous to the June 20 changeover.

What to look at now?

Costco has cleared a big hurdle by getting through its credit card switch in arguably a stronger position than it was before. That's impressive, and it gives the company a solid base of members to leverage over its next fiscal year.

The challenge for the chain is keeping people engaged and visiting its stores when online retailers have eroded its value proposition. So far, the company has done a good job of that, but as online retailers improve delivery options, that's clearly the biggest storm cloud in Costco's future.

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