Please ensure Javascript is enabled for purposes of website accessibility

How Visa is Ringing Up Higher Profits For Costco

By Eric Volkman – Oct 15, 2016 at 3:28PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The retailer's recent switch to the card brand is already helping to boost its bottom line.

Quite reasonably, investor expectations were somewhat muted for Costco Wholesale's (COST 1.10%) recently reported Q4. After all, that's when the company effected its much-heralded switch in preferred credit card brand from American Express (AXP 1.56%) to Visa (V 1.39%) plastic issued by Citigroup (C 1.78%).

Image source: Visa.

Such a monster change unsurprisingly didn't go smoothly at first, but Costco and Citigroup quickly recovered. Which is very good for the retailer, because even at this early stage, the new Visa relationship is clearly paying off.

Swipe and profit

For the quarter, Costco booked sales of almost $36 billion, 2% higher than the same quarter the previous year. Net profit rose by nearly the same figure to land at $779 million, or $1.77 per diluted share. Although the former came in below analyst projections, the bottom line number topped estimates.

The profit rise was particularly impressive because in addition to that revenue slip, several other headwinds blew through the quarter. Wages rose, while there was downward pressure on certain food staples such as eggs.

Luckily, Visa and Citigroup rode in to save the day.

Arguably the biggest advantage of switching out AmEx for Visa is that it's substantially cheaper for Costco -- according to Bloomberg, it's paying "about zero" in transaction fees to the latter card brand. That's well under the 0.6% per transaction it was forking over to AmEx.

Costco doesn't break out those fees in its results. Given the figures we know, however, plus management's enthusiastic description of the impact of the new card brand, the difference is substantial and positive. 

The company's CFO said that net profit defied gravity because the results were "somewhat offset by a variety of other controls and expense improvements, in particular lower year-over-year bank fees as a result of the Amex Citi Visa switch during the quarter." (Emphasis mine).

Getting over it

And what of the two card giants involved in this saga -- are they feeling a similar impact?

We'll get a clearer picture in the coming weeks, as both Visa and AmEx unveil their latest quarterly results. Their previously reported quarters ended on June 30, and the card switch took place on June 20. So it'll be a bit tough to gauge from those results -- at least for Visa, which didn't mention Costco once in its 10Q quarterly filing.

AmEx, the jilted party in the Costco divorce and remarriage, couldn't avoid the subject (it was the biggest news item for the company over the past few years, after all).

As everyone expected, AmEx is still some distance from making up the business lost from the arrangement, which is compounded by the demise of lower-profile co-branding pacts such as the one it had with JetBlue.

But it's recovering well nevertheless, with adjusted (i.e., non-Costco, JetBlue, etc. related) loans rising 11% on a year-over year basis in Q2. Adjusted total billings also saw an increase, at an 8% clip.

Finally, net profit of just over $2 billion ($2.10 per share) came in well above analyst expectations.

Although that number was pumped up by a one-time, $1.1 billion payment from Citigroup for the co-branded Costco portfolio, the windfall was expected by the market. The earnings beat shows that the company is doing a surprisingly good job lifting its core bottom line.


We can expect the Costco deal to provide some upward lift in Visa's results when the card giant next reports quarterly earnings (slated to happen on Oct. 24).

But we should keep in mind that the brand is massive and widespread; as of this past March, it had around 826 million cards in circulation in the U.S. AmEx's total count -- including that Costco co-branded card portfolio -- stood at less than 58 million as of the end of 2015.

Also, Visa's business model is different from that of AmEx. Visa makes its money through those card fees, while AmEx also functions as the issuer of its clients' credit (the role that Citigroup now fulfills for Costco's Anywhere Visa co-branded cards).

Those factors, combined with those wafer-thin transaction fees, will probably not result in a relatively large contribution to Visa's overall revenue. The deal is a positive for the company, sure, but not nearly as much of a boon as it is for Costco.

As I've written before, going by these early post-switch results, it appears that Costco is far and away the big winner in the card change-over. It's got a sweetheart deal with the mightiest card brand on the planet, so there's every reason to believe that relationship will keep bringing extra dollars into the retailer's cash register. 

Eric Volkman has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale and Visa. The Motley Fool recommends American Express. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.