This Small Cap Could be the Next Wal-Mart

February 9, 2011By: James Brumley

While it's unlikely that anything will unseat Wal-Mart (NYSE: WMT) as the king of the retailers in our lifetime, that doesn't mean there aren't major opportunities to meaningfully penetrate the discount-store space.

Take Target (NYSE: TGT) for instance. Despite Wal-Mart's annoying domination, Target has capitalized on the inherent vulnerabilities of the world's biggest retailer and has accordingly chipped away at the behemoth's market share

during the past five years.

More important, the effort has paid off. Target's 2010 income was 60% stronger than 2005's, while Wal-Mart's profits last year were only about 50% better than its 2005 bottom line. The growth-rate gap between the two companies is even wider more recently, as well as on a forward-looking basis. It may seem like a small difference on the surface, but it's not -- investors are noticing, and each stock has reflected the growing disparity.

The moral of the story is simply that bigger isn't better; with size comes vulnerability and headaches.

That's great news for one relatively small and budding name in the discount retail space, though: PriceSmart (Nasdaq: PSMT). PriceSmart is a chain of warehouse shopping clubs, more like a Sam's Club or a Costco (Nasdaq: COST), and less like your local Wal-Mart or Target.

Some investors may feel the last thing this nation needs is another discount retailer, and you may even find some people who feel we need fewer of these stores. PriceSmart doesn't operate in the United States though. It's planted all of its roots in Central America and the Caribbean. And if earnings growth is any indication, it's been doing just fine by focusing there.

The company turned 2005's per-share loss of $1.13 back into a $0.30 per-share profit by the following year, and the bottom line has been swelling each year since. In fact, 2010's EPS of $1.65 was a company record. This year's forecasted per-share profit of $1.99 would be another record-breaker.

As for what any of this has to do with Wal-Mart or even Target, well, there are plenty of historical parallels.

Ever wish you could go back to the late 1980s and buy Wal-Mart shares right as the company was hitting its critical mass of growth? The bulk of the gains for Target were doled out in the mid-1990s, when the company started to follow in the philosophical footsteps of Wal-Mart. Both stocks are deep into triple-digit gain territory since those respective start dates.

Well, where PriceSmart is now in Latin America is where Wal-Mart was in the United States in the 1980s and where Target was in the 1990s, when the appeal of discounts and variety and convenience all in one store hit its full stride.

To be fair, like Wal-Mart and Target, PriceSmart has competition in its market. In fact, Wal-Mart is one of its competitors in Central America. It's just not very good competition.

Central America was actually Wal-Mart's first overseas venture, kicked-off by a 1997 acquisition of Cifra, one of Mexico's biggest retailers at the time. It was a rough start though, as the company and its North American approach didn't fully appeal to the consumer dynamic in that market. The kinks were mostly worked out, but the underlying headache of not being indigenous is likely still lurking.

PriceSmart, in comparison, was built from the ground up in its market by people who truly understand their market, even if it is managed from San Diego.

It's only got 28 stores in operation right now, and the company's market cap is a mere $1.1 billion. That's tiny compared to Wal-Mart's $200 billion market cap. But don't dismiss PriceSmart based in its size, though, as amazing things can happen in time. Just for reference, there were only 38 Wal-Mart stores in 1970 and now there are more than 8,000. Nobody could have predicted such growth at the time.

More important, its small size is a very good thing for investors, as it means a little progress goes a long way on a per-investor basis. And given the way earnings are growing now, progress doesn't seem to be a problem.

Action to Take --> The rise of the U.S. consumer took place a couple of decades ago, but comparable rises in other parts of the world are just now starting to unfurl.

Central America is one of those locales where growth is red hot, putting PriceSmart in the right place at the right time. Investors looking for a reasonable way to garner some emerging market exposure should consider a position in PriceSmart.

James Brumley
Contributor, StreetAuthority.com

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