PSMT - PriceSmart: Fails To Impress On All Parameters

• Inflation and supply chain disruption severely limiting the company's profit margins.
• Q3 2022 results fails to impress with 3.03% net profit margin.
• I assign a sell rating for PSMT after taking into consideration all the growth and risk factors.

Investment Thesis

PriceSmart, Inc. ( PSMT ) is the operator of membership warehouse clubs and is headquartered in San Diego, California. In this thesis, I will analyze the negative effects of inflation and supply chain disruption on the company's performance. I will also examine the Q3 2022 results of the firm and its future growth prospects. I think the company is overvalued at the current price level and has huge downside risks. I assign a sell rating for PSMT on the basis of these factors.

Company Overview

PSMT owns and operates membership shopping warehouse clubs, selling products and services at a low rate to its members. The company currently operates 50 such membership clubs in 12 countries, including nine in Colombia; eight in Costa Rica; seven in Panama; five each in the Dominican Republic and Guatemala, four in Trinidad; three in Honduras; two each in El Salvador, Nicaragua, Jamaica and one each in Aruba, Barbados and the United States Virgin Islands. The company mainly focuses on providing the products at a lower cost than its local competitors in these countries. The company, to some extent, relies on the annual membership fee for providing goods at a lower price than most of its competitors and sustaining the lower margins on the products. The company relies on local and international suppliers to meet its product demand. The company is the largest operator of membership warehouse clubs in Central America, the Caribbean, and Colombia, with a total of 3 million members.

Inflation and Supply Chain Disruption

Inflation has caused severe problems for PSMT in operational efficiency. The company's main feature is providing goods and services at the lowest cost possible, but inflation has led to an increase in commodity prices across many segments. This is putting stress on the profit margins of the firm. And to look at the problem from the consumer's perspective, inflation has led to higher spending on fuel and rent costs, leaving consumers with lower spendable income on leisure products. The demand shift toward essential commodities has left the company with lower gross margins. The supply chain disruption adds to the problem by making the procurement of essential commodities even more difficult. The high fuel prices, increased labor costs, COVID-19 lockdowns in Aisa and Russia-Ukraine war have led to an increased product procurement cost. I don't see inflation going down anytime soon, and this will significantly limit the company's growth. The company currently has only a 3.03% net profit margin, which I believe is very low considering the industry standards. Apart from the product procurement costs, the rising interest rates have compounded the problems by increasing the interest payment burden. I believe the company has multiple roadblocks that it needs to deal with to grow smoothly.

Q3 2022 Results

The company reported net merchandise sales of $999 million compared to $857.4 million in Q3 2021, a 16.5% jump. This increase mainly reflects the marginal increase in the product price. The membership income increased 7.6% to $15.4 million, compared to $14.3 million in the year-ago period. The total revenue was reported at $ 1.03 billion , a 15% increase from $0.895 billion in the corresponding quarter last year. The main revenue driver was increased sales from 3 additional clubs added in Q3 2022 and increased product price. The merchandise sales cost increased a significant 19%, from $720.7 million to $856.8 million. I believe the overall cost increased, given the global inflation across many segments. The company reported a net income of $19.2 million against $22.5 million in Q3 of 2021, a $3.3 million decrease. The increased cost across all segments contributed to the net income decline. The diluted EPS was reported at $0.62, as compared to $0.73 in the same quarter last year. The company has a net profit margin of 3.03%, which is very low even as per the industry standards.

As per my analysis, the total operating expenses are expected to increase exponentially in the coming quarters due to rising inflation and supply chain issues. The rising fuel cost and commodity prices have shifted the consumer demand from leisure and luxury goods to essential goods; this has greatly impacted the profit margins as the essential goods have a lower gross margin. I believe the inflationary pressure will continue in the FY23, and I don't see improving margins for PSMT anytime soon. The demand shift to essential goods just adds to the problems.

Sherry S. Bahrambeygui, Chief Executive Of?cer PSMT, stated,

For the third quarter of this ?scal year, our net merchandise sales grew to almost $1 billion. Our comparable net merchandise sales increased 12.8% over last year, even after taking into account a negative currency impact of 2.2%. Once again, our Membership base set a new record, with a base of over 1.75 million accounts. We also opened our 50th club in Portmore, Jamaica during the quarter. However, like many other retailers, we have not been spared the impact of global supply chain disruption and abrupt shifts in consumer demands. Our hardlines and other non-foods categories are characterized by a higher penetration of imported items that tend to correlate with discretionary spending. Due to long lead times on many of these items, commitments are made many months, if not about a year, in advance.

PSMT has cash and cash equivalent of $207.5 million and long-term debt of $108.1 million. The major problem that the company is facing is the inventory turnout. Currently, the company has $460 million in inventories. This is one of the main issues that the company must address to improve its efficiency.

Quant Ratings and Valuation

PSMT has a Quant rating of hold , and it is ranked 7 out of 7 companies in the industry rankings. The company has the worst rating out of all the companies on this list regarding Profitability, Momentum and EPS revisions. These ratings align with my thesis, and I believe that the company's profitability can see a further decline in the coming quarters.

PSMT has a market cap of $2 billion. The company is trading at a price of $66.31, a YTD decline of 10.21%. PSMT is trading at a P/E multiple of 20.37x. I believe the company is overvalued as compared to its peers, as you can see from the valuation grades in the chart above. I don't see a big upside from the current levels, and there is a considerable downside potential, given the supply chain disruption, inflation and recession fears looming around. The company is troubling to maintain its gross margins, and I think it will worsen in the coming quarters. I believe there are way better investment opportunities in the market in terms of growth prospects and the right valuation.

Conclusion

PSMT is severely affected by growing inflation and supply chain disruptions. The company has very low gross margins, and the margins don't seem to be improving anytime soon. The Q3 2022 results were also not impressive, and according to my analysis, the future outlook is also weak. PSMT is overvalued at current price levels, and the stock has a significant downside potential. I assign a sell rating for the stock after considering all these factors.

For further details see: