PriceSmart: Still Delivering Strong Operating Performance

Oct. 2.11 | About: PriceSmart, Inc. (PSMT)

I first wrote about PriceSmart, Inc. (NASDAQ:PSMT) back on February 13th when it was trading at $37.68. My discounted cash flow analysis suggested a fair value that was 48% higher for an equity valuation of approximately $1.7 billion. Investor who went long on this pick have been well rewarded with the stock price up 65% to $62.32 per share. Most of this gain reflects a multiple expansion from 20.9x to about 29.9x for trailing twelve month P/E. However, trailing earnings have still increased from approximately $1.80 per share to $2.08 per share.

However, is PSMT still a good opportunity? I was initially intrigued by PSMT due to analysis in an earlier article that showed its operating performance to be better than many leading U.S. discount retailers like Wal-Mart Stores, Inc. (NYSE:WMT). The analysis reviewed the following four metrics:

  1. Inventory Turnover.
  2. Cash Conversion Cycle.
  3. Asset Turnover.
  4. Profitability Margins

This article will revisit those metrics to see if PSMT is improving or declining.

PSMT operating metrics remain consistent

Revisiting these metrics for PSMT latest quarter shows similar results. For its fiscal year ended August 31, 2010, PSMT had a 9.4x inventory turnover based on Annual COGS divided by average inventory. For its most recent quarter, PSMT sold $360.3 million worth of goods (COGS) with an average inventory of $159.7 million. This gives a quarterly inventory turnover of 2.3x or 9.0x on an annualized basis. This represents a slight decline from the previous result.

Cash conversion cycle was -3.8 days which suggests that PSMT managed to get paid before they had to pay their suppliers. WMT was the leader in this category with -14.7 days. PSMT is still maintaining a negative cycle, but it has slipped to just -3.1 days.

Asset turnover was previously 2.63x. PSMT had $431.1 million in recent revenue which was down about 4% from the previous quarter. PSMT had $626.6 million in average assets, giving a quarterly turnover asset rate of 0.69x or 2.75x on an annualized basis. This represents an improvement, but is still a little disappointing from the revenue decline.

PSMT historically has had lower gross margins than many other discount retailers with just a 16.6% margin. That is very comparable to the recent 16.4% gross margin for the latest quarter. The operating margin has also slipped from 5.6% to 5.2%; however, the net margin is up to 3.8% from 3.7%. Overall, one would conclude that PSMT is maintaining their margins.

PSMT still undervalued

So PSMT has shown slight improvement on two of the four metrics and slight decline in the other two. However, overall the performance is very similar to previous results. So the decision to stick with PSMT returns to valuation and the multiple increase. The new question is how should PSMT's multiple have changed since my previous analysis. The first factor in PSMT's favor is that long term interest rates have declined. Back in February, the 10-year Treasury bond was a much more robust 3.65% compared to the current 1.92% rate. PSMT beta was .95 compared to .80 now. This suggests a pretty substantial decline in the equity hurdle rate from 9.4% to 6.7% which would allow for significant multiple expansion. Assuming the same long term growth of 4% would allow for multiple expansion of over 2x which more than covers the current multiple expansion. However, if its growth prospects have declined from 4% to 3%, this would only justify 46% increase, which is right in line with the 43% increase that actually occurred. A reduction in growth would be highly justified given the quarterly decline in revenue. My belief is that PSMT is still probably slightly undervalued; however, I don't think it is the same level of undervaluation from February.

However, PSMT is clearly not without risk. If the revenue declines again, one would expect to see the multiple collapse since it is predicated upon maintaining strong growth.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PSMT over the next 72 hours.

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.