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Can PriceSmart Really Be the Next Costco?

Simon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you've been on Fool.com for any appreciable amount of time, you've probably come across the following headline:

"PriceSmart is the Costco of Latin America."

The comparison is likely due to the similarity of the company's business models.  Both sell in a warehouse club format and make the majority of their operating earnings through membership fees. 

But if the statement were in fact true, it would spell out an absolutely amazing opportunity for PriceSmart investors.  For context, PriceSmart (NASDAQ: PSMT) currently has a market cap of $2 billion and has 30 total warehouse stores.  Comparatively, Costco (NASDAQ: COST) has a market cap of $45 billion and has 67 million members.  They are the world's seventh largest retailer and are the largest membership warehouse of the United States. 

Do we have a chance to jump on the train early and ride PriceSmart to the same success that has been seen by Costco?

The History

Keep in mind that PriceSmart was in fact spun off from the same parent company as Costco, which was called Price Enterprises.  The name owes itself to the warehouse visionary Sol Price, who really kick started the whole warehouse club concept back in the 1950's.  Sam Walton, who changed American retail history with the founding of Wal-Mart (NYSE: WMT) and Sam's Club, wrote in his 1992 autobiography Made In America that he had "‘borrowed’ as many ideas from Sol Price as from anybody else in the business.”  It's not hard to see the influence that Price had on the founding of Sam's Club in 1983.

In 1997, Price Enterprises gave Costco the warehouse and merchandising assets for most of its operational locations, but designated PriceSmart to have the license to operate in Latin America.  Starting with just two club stores in Panama at the time of its IPO in 1997, PriceSmart is now in a very enviable position.  It has the tenured management that succeeded with Costco, coupled with a much smaller base of clubs and a whole continent to expand into.

The Side-by-Side Comparison

Fast-forward to today.  PriceSmart is now 15 years old and continues to grow successfully.  It's rather amazing to see how closely the PriceSmart of today resembles the Costco of the year 2000, when Costco's birthday cake still had 15 candles on it. 

Using several different metrics, let's do a side-by-side comparison of how PriceSmart in 2012 compares to Costco in 2000.

Valuation

  PriceSmart Costco
  FY 2012 FY 2000
Valuation    
Stock Price  $              76.62  $              34.69
EPS  $                2.24  $                1.35
P/E Ratio                      34                      26

Stock Prices taken from Nov 30, 2012 for PSMT and Nov 30, 2000 for COST.  Costco 2000 Annual Report referenced from http://media.corporate-ir.net/media_files/irol/83/83830/reports/ar2000.pdf

Starting with valuation, we can see that the P/E ratio implies that PriceSmart today is roughly 30% more expensive than Costco was in 2000.  Is the higher valuation justified?  To find out, we can first look at the companies' financials.

Financials

  PriceSmart Costco
  FY 2012 FY 2000
Financials    
Total Revenue  $       2,050,745  $     32,164,296
Gross Income  $          332,221  $       3,842,126
Gross Margin %                16.2%                11.9%
Net Income  $            67,621  $          631,437
Net Margin % 3.3% 2.0%
Cash Flow From Operations  $            89,889  $       1,070,358
CFO Margin %                  4.4%                  3.3%

Total Revenue = Net Sales + Membership Fees.  Gross Income = Total Revenue - Merchandise COGS.  Revenue, Incomes, and CFO are reported in thousands.

PriceSmart obviously has a smaller footprint than Costco did in 2000.  But side-by-side, they are getting significantly higher gross margins, net margins, and cash flows from operations.  This all means that PriceSmart is putting more change in their pocket for each dollar of sales.

Another way to look at the data could be the following.  Both companies are making the majority of their Gross Income from the membership fees.  Since PriceSmart is getting higher margins (Income/Sales), does this imply that they are selling less ware through each of their stores?

To answer that question (and others), we should lastly look at the warehouses themselves, which are the bread-and-butter of both of these businesses.

Warehouses

  PriceSmart Costco
  FY 2012 FY 2000
Warehouses    
Number of Clubs                      30                    349
Revenue per Club  $            68,900  $          101,000
Total Membership Accounts              965,000         32,800,000
% increase in Accounts (yr/yr)                   18%                   13%
Membership Rate Increase ($USD)                      $5                     $5
Renewal Rate                   88% "All-time highs"*

*Costco mentions in its Year 2000 Annual Report that renewal rates were the "highest in its history," though it did not quantify the values.  Costco's renewal rates in recent years have been nearly 90%.  Revenue per Club reported in thousands.

Indeed, PriceSmart seems to do less sales per club than Costco.  They are also retaining members and adding new ones at a very healthy rate. 

One other interesting thing of note was the membership fee increases.  To further illustrate just how similarly these two companies are being run, both initiated a $5 increase per member in their 15th year of operation.  It's pretty clear that the operation folk at PriceSmart took good notes from Costco.

The Most Important Things to Watch

The comparison of the historical numbers shown above are great for providing context.  The PriceSmart of today is looking very similar to the Costco of 2000. 

But as Foolish investors, we can't solely rely on history for purchase decisions.  There are a few important indicators that we should continue to keep an eye on to judge if PriceSmart can continue to be successful.

Numero Uno:  Membership Renewals are very important.  As with most other businesses, it's easier to keep customers than to find new ones.  PriceSmart must ensure high membership renewal rates to keep income flowing into the company so that the business can continue to keep prices low. 

Numero Dos:  Keep an eye on Gross Margins.  Gross Margins will track the cost of goods that PriceSmart is purchasing.  A decrease in Gross Margins could imply that PriceSmart is receiving price increases from its suppliers that it may not be able to pass along to its customers.  PriceSmart is loathe to increase membership rates too often, so price increases would likely cause them to have to absorb the extra costs. 

Numero Tres:  Performance of New Warehouse Openings.  Many growth companies have the urge to get ahead of themselves and open too many locations too quickly.  This can run the risk of poorer customer service or inventory control issues.

Many analysts on PriceSmart conference calls have asked management when they plan to enter Brazil.  PriceSmart wisely answers that it is patiently opening new stores in strategic locations (currently in Colombia), but that it continues to consider entry into Brazil.  I couldn't be happier with their response.  PriceSmart's 30 locations in Latin America continue to have high renewal rates and exert high degrees of operational discipline.  They are focusing on fulfilling their customers and opening new locations at a controlled pace.

PriceSmart club locations.  One additional warehouse club was added in Cali, Colombia since the graphic was developed.

Conclusion

Costco went public on December 5, 1985 at a split-adjusted price of $1.67/share.  Today's share price is $104.19, which means that any investors that got in on the IPO are today sitting on a 62-bagger.  Returns like that can alter your entire financial future.

After 15 years as a public company, PriceSmart is showing many operational signs that are as good, if not better, than Costco's.  Patient investors might be able to package great returns from the opportunity that presents itself today.


TXinvestor82 owns shares of PriceSmart. The Motley Fool owns shares of Costco Wholesale and PriceSmart. Motley Fool newsletter services recommend Costco Wholesale and PriceSmart. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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