Description

Background

PriceSmart (PSMT) presents the opportunity to short a brick & mortar retailer with low and deteriorating ROIC, declining SSS, minimal FCF generation, and an excessive valuation (>20x EV/EBITDA) - all exacerbated by near-term currency-related challenges.

PriceSmart operates 41 warehouse clubs, similar to a Costco, across 13 different Latin American markets, with Colombia (7 stores), Costa Rica (7 stores), and Panama (5 stores) representing its largest markets.  Although its revenues are derived from these markets, the company is based in San Diego, with its primary distribution center in Miami, and trades on the Nasdaq with a price quoted in US dollars.

Each store is relatively large (~45-50k sqft) and high-volume (~$75M per store), driving to ~$3.1B in FY18 retail revenues.  In addition, similar to Costco, PriceSmart sells memberships.  It has approximately 1.5M members (2.8M cardholders) generating ~$50M in annual membership fee income (or $35 per member per year). 

Thesis

Over the last five years, PSMT has grown revenue at a 7% CAGR as it has expanded its store base from 31 to 41 units.  But this expansion has been unsuccessful and value-destructive.  ROIC was ~15% in FY14 but was <10% in FY18 as the business has invested ~$240M of new capital but seen earnings decline as OM% compressed ~140bps to 4%.  SSS has similarly deteriorated, as a business that was comping MSD-HSD five years ago saw ~1% average SSS over the past three years, and a 2% SSS decline in the most recent quarter.  As you might expect, this has added up to horrible FCF conversion: PSMT has generated <$100M in FCF over the last four years, and <$10M over the last two years, spending a total of $400M in capex just to (not quite even) run in place.

In addition, PSMT continues to face substantial currency headwinds.  As noted above, the company reports and is quoted in USD, but locates its operations in Latin America.  Its two largest store-count countries, Colombia and Costa Rica, have seen their currencies substantially depreciate over the past year, with the Colombian peso down by 15% vs the dollar and the Costa Rican Colon down 6%.  In total we estimate a 4-5pt growth headwind to the business (in addition to margin pressures from the USD-denominated corporate and distribution overhead).  Indeed this has begun to manifest in early FY19 as (even with tax benefits) PSMT has reported 1H earnings per share of $1.27, down ~22% vs $1.63 in F1H 2018.

Despite this, PSMT remains wildly overvalued, trading at ~25x FY19 P/E.  We believe this is far too expensive for a retailer with declining same-store-sales, mediocre and deteriorating ROIC, no FCF, and sharply-declining earnings.  Bulls would note the high-quality membership fee revenue and the comparison to Costco, a high-quality business with a similar model.  But even in that light PSMT looks substantially overvalued. 

Costco is often considered to derive the overwhelming majority of its profits and value not from selling goods but instead from annual fees from its membership base.  Last year it earned ~$3.15B in annual membership fees, a number that grew 10% year-over-year (and has annual membership retention of 90%).  By comparison, PSMT has $50M in annual fees (growing 6% with 85% retention).  Given those characteristics, you might reasonably expect to pay more for Costco's higher-retention, higher-growth membership fee stream attached to a more scaled franchise.  Not so - at $62 per share, PSMT trades at ~37x membership fee income compared to Costco at 34x.

We believe the company should and will re-rate towards a mid-teens multiple (if not lower), in-line with similarly growth and returns-challenged retailers.  15x $2.50 in FY20 EPS results in a price target of $37.50, or >35% downside from today's levels.  More broadly, we are happy to let the stock die a slow death and be short an overpriced asset with no growth or FCF.

Catalyst

Continued downward earnings revisions as currency pressures roll into the model

Continued ROIC deterioration amid further store openings and online/logistics expansion