“It’s time to BUY!” Hilary Kramer’s “The Next Costco”

by Travis Johnson, Stock Gumshoe | July 16, 2012 2:11 pm

Sleuthifying Hilary Kramer's latest teaser pick

I haven’t written about one of Hilary Kramer[1]’s “Gamechanger” stocks in a while, so while lots of folks are feeling blue, doldrummy, or just plain pessimistic during the ides of July I thought I’d throw in a little of her optimism for you. She’s teasing a few stocks that she thinks her subscribers should load up on “while they’re on sale.”

So what are they? Don’t worry, we’ll look at the clues — but first, the big-picture for her optimism:

“When I launched GameChangers[2] two years ago, plenty of people thought it was a crazy time to start a new investing service. It was the first year of what seems to be our new recurring pattern — strong first quarter, volatile second quarter, dismal summer.

“But what I knew was that if I could get investors into the right stocks, we’d make gains no matter what ….

“We took that “dismal summer” and turned it in to a buying opportunity. Yes, we bought all summer long and into September, even as the markets tanked and everyone else was selling….

“Take a look at a two-year chart for the Dow, NASDAQ or S&P 500, and you’ll see the pattern we already discussed: strong first quarter, rocky second quarter, dismal summer. Then comes the part that everyone seems to forget when volatility hits — a rally that kicks off in the fall.

“Put your money in the right stocks now, and you too will be handsomely rewarded. Remember, GameChanger stocks are companies that will continue to thrive in any sort of environment. Add in a Fed that won’t hesitate to act to keep the recovery going and the fact that in Presidential election years the markets are more likely to finish stronger than they started, and you’ve got a perfect recipe for profits.”

And then the clues — what is it that she thinks is “on sale?” We’ll look at one of ’em today:

“The first stock on our shopping list is the Costco of Latin America.

“There’s a new consumer class emerging in Latin America…and this company has a proven way to get a piece of the action.

“Per capita income in the region is up an eye-popping 57% in the last decade, and the middle class now makes up more than half of the major economies in Latin America….

“This retail giant is run by the two men who pioneered the very profitable warehouse concept in the U.S., and now they are bringing their vast selection, discounted prices, and consumer-friendly business model to the booming consumer class in Latin America as well.

“While they are headquartered in the U.S., management has made the critical decision to operate in Central and South American regions where it is the only U.S. style warehouse club, so competition is minimal.

“Revenues have increased a whopping 133% since 2006 to $1.7 billion, and earnings have grown an astounding 590% over the last 5 years. And that’s in the middle of a global financial meltdown no less….

“Membership income is increasing rapidly (up 16% last quarter alone with an 18% jump in the number of new members) and there is tons of room to expand operations in other parts of Latin America.

“With so many compelling forces driving success, I’m looking for a quick 40% gain with even bigger profits long term.”

This one’s a pretty easy chew for the Thinkolator — here she’s teasing PriceSmart (PSMT)[3], which has also been recommended by other newsletter folks in recent years (it was also the Motley Fool[4]’s pick as the Top Stock for 2012). They are indeed often referred to as the “Costco of Latin America,” and they come by that name honestly — you might remember that Price Club was one of the pioneers of warehouse club shopping before they merged with Costco in the early 1990s as a ploy to fight off Walmart’s Sam’s Club. The merger was rocky at the start and the founder of Price Club, Sol Price, basically took the international expansion of the concept as a spinoff company shortly after that merger and used that as a base for establishing a mostly Latin American warehouse shopping club, eventually calling it PriceSmart.

PriceSmart had a rough run for many years — they made mistakes by expanding in the wrong places (Mexico[5], where Walmart dominates) and by focusing on some low-margin products for a while, but they seemed to get the company back in gear and refocused with Sol’s son, Robert Price, coming back into leadership for a brief period, and since 2005, when they closed some warehouses and reorganized a bit, the stock chart clearly shows the recovery. The stock got cut in half during the financial crisis, like pretty much everything else, but bounced back admirably.

Which is not to say that it’s a “no brainer” at these prices — the company earns pretty low margins, it has large competitors despite the fact that they’ve so far avoided direct competition in many of their markets, and is dependent on consumers in emerging economies, and it’s no longer a turnaround play or a beaten down stock: the shares trade at a forward PE of 25, and analysts think they’ll grow earnings at something like 15-20% a year going forward — so the valuation is fairly similar to the far larger Costo (COST), which has a lower forward PE and lower expected growth rate, but not by a huge margin.

They’re small (market cap of $2 billion) and don’t carry any net debt, so that’s positive. They also have really narrowed their focus, they now have 29 warehouse stores and all but one of them are in Central America and/or on Caribbean islands (the one other is in Colombia[6]), and it would seem that they need to ramp up expansion if they’re really going to generate big earnings increases over the next five years — though they do manage to eke out higher margins that Costco. Costco has a very aggressive cost-cutting and margin-cutting strategy that means they consistently get gross margins of about 12% every single year (meaning, they mark up their products by 12-13%) and get almost all of their profit from membership fees. PSMT marks up sales more and operates smaller stores with slightly higher operating margin costs, but over the past four years PSMT has turned 3 or 3.5 cents of each dollar into profit while COST has earned only about 1.6 cents per dollar of revenue. So PriceSmart is doing something right, particularly lately as they’ve cut into operating expenses considerably, but at this point it looks like they’ve gone through a lot of the low-hanging fruit and they’re going to need to start expanding again in order to get revenue growing at the pace investors would like.

And they ought to be able to, one imagines — their most saturated market is probably Trinidad and Tobago, where they have four stores for 1.5 million people, and many of these smaller countries like Guatemala, Nicaragua, Panama[7] and the like could almost certainly handle more warehouse stores near what are in some cases substantial urban areas … if they wish to be aggressive, I’m sure they could also take up some market share in places like Colombia, too, or elsewhere in the smaller countries of Northern South America like Ecuador, Peru[8], etc. Mexico, Brazil[9], Argentina[10] and Chile[11] are probably big enough that it’s not worth the cost of breaking in, but there are a lot of other economies that are underserved in this kind of retailing.

Hilary Kramer may be, as one of the columnists from the Financial Times reportedly called her, “A One Woman Financial Investment Powerhouse” (I can’t verify the quote, but she uses it a lot) … but that doesn’t mean she always picks or promotes good stocks. She did, after all, pitch us on the potential for a quick 40% profit from fat-freezer Zeltiq Aesthetics (ZLTQ) back in January, and that one fell in half within a couple months of her teaser ad and hasn’t recovered, so don’t assume that her stamp of approval is a golden guarantee.

Still, PriceSmart is in a nice little niche and they have really restored good, sober management to the company over the last four or five years … I’d argue that the stock is valued pretty fairly if you think they’re just going to keep plugging along and opening an average of one new store a year, but that it could be a nice entry point if you believe they’re going to ramp up considerably and turn Colombia, for example, into a significant hub of operations (their first store there has been open less than a year, but reports I’ve seen say they plan two more warehouses in Colombia this year — which is a good step, I think).

PSMT has come down considerably from the ebullient highs of the Spring, which were partly inspired, perhaps, by the Fool highlighting it as the top pick for the year — that’s partly because of a lack of confidence about emerging consumers, perhaps, but the key in the stock’s downward slope over the last couple months has been sales growth that failed to meet expectations, and rising expenses that hurt the last quarter’s results. Part of that’s also the dollar, to be fair — they earn all their revenue in local currencies around Central America, but they report in dollars and incur a lot of expenses in dollars, so when the dollar is stronger than the currencies of our southern neighbors that can bring down reported profits as well. Still, even though they’ve failed to meet expectations in some quarters there’s plenty to like — including plans to increase membership fees, which go right to the bottom line, and same-store sales growth that has continued to be strongly in the double digits at 10-11%, an “organic” growth rate that would get most retailers salivating.

The big picture is that they are profitable, they have good margins for their business, they pay a dividend (a tiny one, less than 1% now, but still a dividend), and they seem to be doing a pretty good job of slowly spreading the warehouse club concept, including tire stores and photo printing and bakeries and the whole shebang, into smaller markets in Latin America. They might deserve this premium price for the stable base they’ve consolidated since 2007-2008, including a proven ability to relocate or close faltering operations, but they’re probably going to have to ramp up expansion and successful new store openings if they want to keep this premium over the next few years. A good bet, perhaps, on the consumers of the Caribbean basin wanting cut-price US consumer goods and a US-standard shopping experience, but at these prices I think they’re going to have to grow without too many more growing pains.

What do you think? Interested in some PSMT shares and think we’ve got a 40% jump coming, or are they not marked down to your sale price yet? Let us know with a comment below.

And, as always, we want to know what investors think about the newsletters they subscribe to — if you’ve tried out Kramer’s GameChangers, please click here to share a quick review with your fellow investors[12]. Thanks!

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