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In the spring of 2017, I concluded that investors in PriceSmart (NASDAQ:PSMT) should be smart and hold off on the shares. The company has been lagging compared to its much larger peer Costco (COST) as growth has come down quite a bit after years of double-digit comparable sales growth amidst a strong dollar and difficult conditions in Columbia at the time.
I noted that the company is well positioned to maintain and build out a dominant position in Central America, yet valuations were still a bit demanding, as political risks are above average of course.
Thesis
Founded in 1996, PriceSmart was founded by Sol Price, who previously founded FedMart and Price Club, the latter of which actually merged with Costco in the 1990s. Headquartered in San Diego, the company has grown to operate 39 big box clubs in Central America (back in 2017), located in 13 countries. The company had 1.5 million members, on average paying $35 annual member fee.
After a run higher in the 2000s, the company had to undergo a painful restructuring as shares fell to just $5 in 2004. Ever since then, the company has seen very steady growth with double-digit growth seen year over year, albeit the relative strong dollar always was a matter of attention.
In 2017, the company saw shares trade at $87 per share, equivalent to roughly 28 times earnings, and with revenues reported at $3.0 billion, the sales multiple came in at 0.8 times revenues. These were demanding multiples, on the back of the solid growth reported in recent years and a strong net cash position of $50 million, despite the continuation of opening of new stores.
Further growth in comparable sales growth was needed as a small increase in margins could reveal upside in earnings to $4 per share, yet even in that case valuations were quite high, as the risk-reward in the high-eighties simply was not that compelling.
Soft Results
In the five years since my last take on PriceSmart, it is very evident that investors have seen disappointments as shares actually fell back to the $60 mark in 2019 amidst political issues in Central America. Shares rallied to the $100 mark again in 2021 amidst the pent-up demand following the pandemic, but ever since then it has been all downhill again with shares now trading at $65 per share.
Fast forwarding from the 2017 base, we see that PriceSmart has seen modest growth over the past couple of years, with sales up nearly 9% that year to $3.6 billion. Growth has been relatively modest in the period 2017-2020. Operating earnings of $158 million translated into margins of 4.4% and have never been able to come back to the 5% mark. This modest margin pressure made that net earnings for the year came in at $98 million, with earnings posted at $3.18 per share, marking hardly any progress from 2017.
In the meantime, net cash balances have risen to $125 million, up to more than $4 per share. With shares trading at around the $70 mark at the time, the multiple (after backing out net cash) has come down from a high twenty times multiple to 20 times, as the recent performance in recent years, simply has not been up to standard.
Productivity of the stores is an issue as the company reported a store count of 49, up 10 from 2017, as revenues per store have really not advanced over the past couple of years, something which pressured margins of course.
In January, PriceSmart posted an 11% increase in first quarter sales (driven by some store openings in recent times) with earnings rising accordingly. In April, second quarter results revealed another 11% sales growth amidst inflationary pressures as the company actually saw earnings growth in line with the topline results.
By July, third quarter results rose 15% which looks very comforting, but is mostly the result of strong inflation as currency headwinds only detracted just over 2% of the reported sales. The problem is that third quarter results actually showed a decline in absolute earnings with operating margins down to the low 3%.
This made that quarterly earnings fell eleven cents to $0.62 per share, albeit earnings are flattish so far in the first three quarters of the year, with earnings set to trend at $3.25 per share here for the year. At the same time, net cash is down to $80 million following investments and working capital changes, still marking a decent cash position of nearly $3 per share.
With shares now trading at $65, the operating asset valuation comes in at $62 per share, as the earnings multiples have fallen to roughly 20 times.
Concluding Remarks
The truth is that PriceSmart has been hit by years of softer growth and declining margins, after it was a hugely successful franchise in the 2000s and earlier part of the 2010s. By now the company has grown to 50 stores and a run rate of $4 billion in sales, yet the issue is that the company in the long term is simply seeing more competitive pressures, and in the near term is hit hard by a strong dollar, inflationary pressures and supply chains issues.
The good news is that higher inventory levels (as some goods are apparently in sufficient quantities) have triggered price declines which hurt near term margins, but reveal that margins could recover a bit in the near to medium term.
Right now the valuation seems to have been derisked quite a bit. Long trading at around 30 times earnings, the multiple has fallen to a high-teens multiple all while operating margins have fallen a percent or two, as margins are key, as roughly every point in operating margins is equivalent to earnings of a dollar per share.
Hence, if margins can see some recovery, I am talking just 4% operating margins, there is real upside potential. In reality, PriceSmart has been lagging for years, making hopes for a near term rebound not so credible.
The strong cash balance and secular growth is nice, yet the issue is that a strong dollar will not be alleviated anytime soon. The company is simply facing tough operations, running relatively few stores in many countries in different political systems, not an easy task. Hence, valuations look a lot more fair, with shares actually down 25% over the past five years, yet I do not see screaming appeal just yet.
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