Business Breakdowns
· 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.
· Markus Hansen
And this is why I think this is a company – again, you have a very nice path to sustainable growth, assuming none of the bigger countries hit any sort of large macro dislocation, which is why I think they're being very careful in terms of the larger markets they're going to. They've been very good in terms of diversification. You never want to go through a tough time. The good news is if you navigate it well, it reinforces the model. Hurricanes impact a lot of the Caribbean. They've designed their stores to be hurricane-proofed. Each time it gives them actually more share because people come to recognize, that guy's still open 24/7. I can go there. They help out with the local emergencies, but they really garner a lot of goodwill. The same, I think, we'll see in places in South America where they will start to deliver this idea of a great, um, everyday low price type offer through this idea of the club membership. And when you go into an economy and saying to someone – $45, that's a lot of money. Look what you get for it, by the way. You get healthcare, basic healthcare, but healthcare checks for your kids and family in that price. You would pay that already. And by the way, you also get to come in and shop at a discount. That's pretty powerful. And getting the word out there is pretty good. One thing I would add people have asked about, what about the impact from e-commerce? There are some very smart e-commerce operators in the markets they are in. Amazon is in a couple of these markets. If your listeners don't know, the Amazon of South America called Mercado Libre, they're doing a very good job. Keep in mind that they're predominantly geared towards merchandise, very much around electronics and fast-moving stuff. So they are a competitor. But again, very different in terms of if we look at the food side of things and then think about the heavier, bigger stuff that you're gonna pick up, like garden furniture and stuff. That's still harder to do. But they're aware of this. They are looking at the idea of some sort of e-commerce down the road using their stores as the pickup side of things. But that still is an area where – and I'll come back to you mentioned – so there was a change in management in the last 2 years. It was interesting.
· Markus Hansen, Matt Reustle
The grandson who'd been working his way through took over officially as CEO, and they brought in a new CFO who comes with a strong track record of management in South America, which again adds to this understanding that South America is where we may see them lean into places like Chile's new markets. And he has some experience on that side, particularly with a place like Chile where e-commerce is a bit more developed. So I think 2, 3 years from now we'll hear a bit more of that CapEx going into that side of things. But right now, CapEx really is just building more of these stores, bring the DC along, and just leaning into this operating leverage over time. [00:00:00] S0: Yeah, it's interesting when you have a proxy in the US. I'm gonna beat it to death, but Costco and their ability to thrive throughout the e-commerce revolution is an interesting case study too, relative to this. Everything you mentioned there has some added credibility when you look at how things have managed here. In terms of looking forward and the risks that do exist, you've referenced many risks that theoretically exist, but what would stand out, if anything, the most to you in terms of what's most important to get right to fulfill what's possible in the future?
· Markus Hansen
[00:00:00] S1: Yeah, really keep doing what they're doing, not rushing anything, changing anything dramatically. I think certainly private label continues to be an area – if you look at best-in-class US, Costco about 33%, Sam's Club I think is just above 30% from the disclosure I saw. They're right now at 19%. The ability to maybe do more of that going forward. That tends to be more, if we think on the fresh side, the ability – so one area right now they'll talk about on the call is developing a private label chicken offer. And this is going out and finding some large farmers they can deal with locally. A lot of that is sourced, so it's building goodwill with the local guys. But getting the type of quality which is consistent, rather than just being one little store where you can come in, getting this across 10 stores. So in the bigger markets, I think that's feasible. We'll see more of that. That's margin improving, because generally you enter a private label transaction because it's margin improving for the same type of thing you're offering. It also builds your reputation. Once someone is buying something from you on the fresh side for the first time and is really good quality, you're more likely to go and try their other stuff. And as we know, Costco is renowned for its famous shrimps. Obviously then you do the things like the chickens, the hot dogs and all this stuff. Most of the time when we go for something fresh, we really want a brand at first, we're gonna go try something which is local but really good quality. So I think there's more they can do there. The other part I think is some of the other services they can do. So right now it's pretty straightforward. You talked about how you were going to the auto to get your tires. They don't do that right now. That is an area where – auto is an interesting one given how they're located, they have the parking area. It might be something they might do in some of these larger economies as well. It's an added service. And most of the times what they're looking at is areas where there is fragmented competition, but where – coming back to this idea of convenience – if you can go and get all this done and say – remember we talked about Casey's, we sell you time, the most valuable commodity you just cannot get enough of – makes your day even better. And that's very powerful.
· Markus Hansen
Also getting the benefit of then these are the kind of things where you can think about bulk supply, whether it's tires or auto parts. That could be something down the road. They haven't talked about that, but it's interesting. That's an area where, from both a dollar point of view, the ability to offer discounts, and the type of customer they're going for, that would make a lot of sense. These are still avenues of growth. So I think this is more once we get to a certain scale. But really it's bringing this great, consistent, good quality, solid reputation to these local markets and it's working very well. And then it's really leaning into this – there is this long-term structural growth of US citizens moving to these markets to live, sometimes for work and then staying there. But also, people from a lot of these countries who've come to the US, worked and gone back. And that experience immediately kicks in. And the more and more communication they're doing on that side is working very well. But the final part was really this ability to lift up the membership number. People at first thought that maybe they'd move from the average. When they started, it was like $30 going to $60, it's now $45 to $90. It's a big number going locally. It's working very well because I think they're emphasizing, yes, that's a big number, but look at all the benefits you're getting. When you do the math, it makes a lot of sense. And this is why we're seeing very low churn. You've almost got like a 90-91% renewal rate. It's higher at the higher end. It's almost close to 100, but granted that's a smaller base, but that's telling you that those who are doing it really are seeing the benefits and it's working, because this is just general spending anyway. People do maybe have another option, but this is really bringing them in.