PriceSmart, Inc. (PSMT) is a small scale wholesale club company with potential upside if it can continue its growth trajectory. It operates in Central America and the Caribbean and has been growing quite rapidly in the past two years. PriceSmart's comparable companies in the United States would be Costco Wholesale Corp. (COST) and BJ's Wholesale Club, Inc. (BJ).
"PriceSmart, Inc. owns and operates warehouse clubs in the United States, Latin America, and the Caribbean. Its warehouse clubs sell consumer goods and perishable foods at low prices to individuals and businesses, as well as offering ancillary services, which include food courts, tire centers, and photo centers. As of August 31, 2010, the company operated 27 warehouse clubs in 11 countries and 1 U.S. territory, including 5 in Costa Rica; 4 each in Panama and Trinidad; 3 in Guatemala; 2 each in Dominican Republic, El Salvador, and Honduras; and 1 each in Aruba, Barbados, Jamaica, Nicaragua, and the United States Virgin Islands. PriceSmart, Inc. was founded in 1994 and is headquartered in San Diego, California." (from Yahoo!Finance)
|Ticker||Price ($/share)||Enterprise Value ($ Billions)||Trailing P/E||Forward P/E||Revenues (ttm) ($ Billions)||Fiscal Year End|
|COST||$ 75.04||$ 27.8||24.6||18.6||$ 79.9||August|
|BJ||$ 49.37||$ 2.3||18.9||15.2||$ 10.8||January|
|PSMT||$ 37.68||$ 1.1||20.9||15.6||$ 1.5||August|
Data sourced from Yahoo!Finance on February 13, 2011.
Discounted Cash Flow Analysis
I completed a discounted cash flow analysis on PriceSmart to evaluate it as a potential long investment. The discounted cash flow method is one of the basic tools for valuing companies. Essentially it states that the value of an enterprise is equal to its future cash flows discounted at an appropriate rate to account for the risk in those cash flows. This methodology produces a value that is reflected to the expected cash flow. It does not provide any insight into potential variations or risks. The appropriate discount rate is based on whether the cash flows have been adjusted for servicing debt or are prior to debt service. I used the unlevered free cash flow method which targets an enterprise value. The appropriate discount rate should then reflect both the cost of debt and the cost of equity. In this case, a weighted average cost of capital (WACC) is appropriate. The required equity return can be calculated using the Capital Asset Pricing Model (CAPM) with an equity risk premium, an equity beta, and a risk free rate (approximated by the 10 year U.S. Treasury Bond rate). The unlevered free cash flow in its simplest form equals net income + depreciation/amortization – changes in working capital – capital expenditures + interest expense * (1 – tax rate).
The appropriate discount rate is based on whether the cash flows have been adjusted for servicing debt or are prior to debt service. I used the unlevered free cash flow method which targets an enterprise value. The appropriate discount rate should then reflect both the cost of debt and the cost of equity. In this case, a weighted average cost of capital (WACC) is appropriate. The required equity return can be calculated using the Capital Asset Pricing Model (CAPM) with an equity risk premium, an equity beta, and a risk free rate (approximated by the 10 year U.S. Treasury Bond rate). The unlevered free cash flow in its simplest form equals net income + depreciation/amortization – changes in working capital – capital expenditures + interest expense * (1 – tax rate).
|Risk Free Rate||3.65%|
|Equity Risk Premium||6.0%|
|Required Equity Return||9.4%|
|Cost of Debt||6.0%|
|Year||Status||Revenue||Revenue Growth||Net Margin||Net Income|
Historical data sourced from Yahoo!Finance on February 13, 2011. Projections based upon 11% revenue growth with improving SG&A efficiency to drive down net margin.
|Year||Status||Days Receivables||Days Payables||Days Inventory|
Historical data calculated from Yahoo!Finance and projections based upon most recent full year.
|Year||Status||Net Income||Depreciation||Change in Working Capital||Capital Expenditures||Unlevered Free Cash Flow|
Historical data is from Yahoo!Finance and projections based upon methodologies described above. Capital expenditures and depreciation were escalated to maintain certain operating metrics.
Table 7: Price Appreciation Potential ($ Millions)Data based on model projections. Current Equity Value from Yahoo!Finance.
Valuation Component Value Enterprise Value $ 1,661 Debt and Liabilities $ 68 Cash $ 75 Potential Equity Value $ 1,668 Current Equity Value $ 1,130 Potential Appreciation 48%
PriceSmart, Inc.'s current valuation may offer significant price appreciation potential based upon the assumptions used in my model. Furthermore, relative to its comparable companies, it appears to have a consistent valuation despite stronger growth prospects.
One challenge for PriceSmart will be to continue growth within its existing geographical market. Furthermore, the required equity return at 9.4% might be too low for the country risk and challenge of operating stores in so many different countries. Slower revenue growth, stagnant margins and a higher beta (1.5 versus .95) would suggest a fair valuation. The key trade offs for the company will be ability to grow profitability and better leverage its scale.
Additional analysis should be completed before making an investment decision.
Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.