Business Breakdowns
· Markus Hansen
[00:00:00] S1: Exactly. I think you hit the nail on the head there. Right now, the scale of the company, given that it's in these 12-odd markets, $5 billion of revenues – most of it, if you have one market going through a bit of volatility, it's more than managed by all the others. Colombia is interesting because it is the largest in terms of single footprint. And like I mentioned, this is a market where I think, based on the analysis I've done of GDP, the addressable market in terms of middle class and upper spending and the ability to broaden across a large economy could easily be by itself 25 stores. So that could more than double. Then within the group, it gets bigger. That one actually then could be a bit more volatile, but in a place like Chile, which actually is less volatile relatively, could offset that, which I think is how they're thinking about it. So far, they've generally managed it. There'll be maybe 1 or 2 quarters where you see a bit of a wobble, but over the course of the year, the actual compounding is pretty relatively stable. Part of that I think is that they are targeting a less volatile part of the consumer complex, who generally has a wealth that is going to go and shop anyway. Remember, we're talking about this isn't the only place they'll shop. For a lot of other things, they're going to go to other supermarkets, but this is going to be their core go-to. And then the beauty of this is the single biggest driver of operating earnings right now, about 40% of their operating earnings, comes from the upfront payment of the membership. So already at the beginning of the year, as you subscribe, you already have locked in about 40% of your earnings. That's a great visibility to have as you're negotiating the rest of the year. The real driver, I think, the only contingency here would be this idea of not just recruiting new members, which is growing quite nicely, but getting members to move up to the higher tier. Right now, to give you a mix, just under 20% of their membership base is the higher paying $90, what they call the Platinum card. And then the rest is the $45. But that has grown from 12% just 5 years ago. And what they're doing there is more and more explaining the benefits of this, that it sort of pays for itself with the cashback. There's about a 2 or 3% cashback you get, on top of the added benefits you get.
· Markus Hansen, Matt Reustle
Where this is really resonating though is they're becoming a go-to supplier for small and medium enterprises. Think little restaurants, small hotel chains who are looking for that quality, really targeting American tourists or people who like a Western-style standard. They're bringing stuff in from Europe, but mostly American-type snacks or food products as part of that offer they're getting. And that's driving another area where they're leaning into more as well. So right now, $5 billion of revenues, I think it's very manageable across their diverse base. Hopefully we're having this conversation 5 years from now, there'll be $10, $15 billion plus. Then I think once we get to that scale, it could be. But right now it is manageable and they've done very well on this. The only thing has been this trapped cash issue. It's a high-class problem to have. You are producing way too much cash in the market, you want to get it out, but they're managing it in a good fashion. [00:00:00] S0: Is it a similar story in terms of the gross margin stability and general approach or sensitivity on margins? You mentioned some of the FX dynamics and how they approach these things, but how would you compare it to just the US price clubs?
· Markus Hansen
[00:00:00] S1: So they're trying to put in as best they can of that. So the idea of owning the logistics, in terms of distribution center all the way down to delivering to your local actual store. The more they control of that, the more they can, a) as a bulk buyer, get the benefits of that, coupled with the fact that they start to become a sizable local customer for a lot of their suppliers, who generally are dealing with a lot of SMEs. Which probably gives them some – I mean, they do emphasize they're not out there to get the lowest price possible. They really want to work with the local farmers. They want to look with the local fishermen, get you to scale. And so, this is a company which I think actually, if you were to be a full-on capitalist, probably under-earns specifically to ensure that its supply chain is a sustainable, long-term that can grow with them over time. To bring a good quality product where they're not looking to get the best margin possible, just to deliver a product for good value for money for their customer. Relative to what they see obviously in terms of the market out there, but understanding that is more long-term sustainable than just going for a hit and run, let's make as much money as we can. And that again comes back to this DNA. If you get the chance to read the book or the reviews of the book, Sol Price is also very much driven by being a good member of the community. And that ties in with the philanthropy they do outside of this, but not just in dealing with charities, but developing local areas. So those people who live in San Diego probably know him better because he actually has been instrumental in redeveloping the downtown area of San Diego, which had been up and down through industrial and the spending on war and of the Department of Defense. To make that a nicer place to live, but also open to the community and the social side. And they do a lot with kids. It's a very sad story. His grandson died young. It affected him in the sense that he felt that there was a part of society which didn't have access to the right kind of healthcare. But on top of that, just embracing – if you do well for your community, community will do well for you as well. And again, these are the stories which I think we often forget about. Got a guy down in Hershey, Pennsylvania.
· Markus Hansen, Matt Reustle
I think there's a movie coming out actually that talks about that story. These are the do-good capitalists who realized in times of crisis or when times are tough, invest with your local community and they'll stick with you through thick and thin. And again, this comes back to the kind of nature of what's going on in a more modern society. [00:00:00] S0: Yeah, become staples of that community and represent something inside of it. You've touched on some of the decision-making around real estate and CapEx and just high level what would factor into capital allocation decisions, but what has been their historical track record of doing anything as it relates to dividends and buybacks, reinvesting in the business? Obviously they have some cash that might be trapped in certain spots, but a good problem as you mentioned. What's been the historical track record around capital allocation?
· Markus Hansen
[00:00:00] S1: When they go into scale in the market, initially the returns on capital tend to be at the lower end of the range. Generally, the store paybacks are pretty quick, so the store can become profitable within 2 or 3 years. So to give you an idea of the size of the store, if you think of a traditional Costco you go into today, they're about one-fifth the size of the larger ones. So a lot smaller box, but big for where they are locally. Those stores, if they add in a distribution center around it, very often will take maybe an extra couple of years to bring back the returns. But once they get to 5 stores, there's a densification effect in a local market. You then start to see operating leverage improvement, and they design the distribution center with the ability to expand it fairly quickly. Again, I've seen this playbook with – whether it be Casey's or certainly Walmart or Costco as well. This is where the key ownership of the store land or the actual store box is important, because they build in redundant flexibility, which can allow them – this is why they've confirmed they're working on Chile, but Chile will be interesting for your viewers if they want to follow this going in the next couple of years. Once they announce a location in the start of that, the discussion in the first 2 years will be how quickly they get the DC open and so forth. Generally, you're looking at a business though, where the top line growth through this controlled period of time, and on average they're adding between 3 to 4 stores per annum across the network. If that store is in a more densified area, it probably kicks in a lot quicker. But on average, they're spreading these around. So there'll be one store in one market, one store in another. This is off a base of 61. So that gives you some underlying growth. Then on top of that, they're growing the core same-store customer at a mid-single-digit growth rate coming in. That customer, one in five of them is converting right now to the increased platinum spending. So you got these drivers in terms of the mix is improving while it's growing, and the actual store size is growing as well. And then the operating leverage once they get above a certain level in each market, from the DC side.
· Markus Hansen
So this is a business right now which is doing $5.5 billion of revenues forecast, about $350 million of EBITDA, and about $250 million of EBIT. Pretty consistent. And like I mentioned, close to 40% of that on the EBITDA side is money paid upfront in terms of the membership. So good visibility, the ability to turn – cash flow generation is fairly decent. Cash conversion is running at close to 90-plus percent. Keep in mind, this is mostly food. Yes, there's general merchandise, but it's pretty quick turnover merchandise. So the cash conversion rate is very attractive, like any retailer would want to be. And again, their supplier terms tend to be very good as well. As they get bigger, they don't lean into that. I like that. Like I said, these guys could print more money if they want to do. They deliberately decide not to because they see the long-term benefit alignment of growing their business with their suppliers. To get bigger, you need a supplier that you can rely on and they grow together. The alignment here is very – and we've done some work speaking to some suppliers who speak extremely highly of this. It's very powerful. And this is why the runway, if we look at both the population – so the population area is, right now I mentioned about 2.5 million core paying subscribers. This is a current population area which is about 70 million. So if you think about the tangible size of the middle and upper class in those markets, particularly if we get a place like Chile coming on board, the number of customers they could get to is a multiple of that over time, coupled with the fact that's more likely a higher paying one as well. So that mix of that customer, if we go from 2.5 to 5-6 million, half of those could be the higher end paying within a decade or so. And that's going to give you a very nice earnings growth over time. We're looking at double digit here right now, about 11-12%. Dividend's a bit small right now. The yield is not big, it's about 1, 1-something percent. The balance sheet is pretty much underlevered. They virtually carry little if any debt. And it's really more about investing in the business going forward.