2024-01-11 02:19:06 ET
Summary
- Five Below's recent performance disclosures have led to a more bullish outlook, with growth momentum expected to continue into FY24.
- The company reported strong sales growth in 3Q23 and 4Q23, with net sales accelerating and same-store sales improving.
- Five Below's aggressive store expansion plan and focus on converting to the Five Beyond format support expectations of continued mid-teens growth.
Investment action
I recommended a hold rating for Five Below, Inc. ( FIVE ) when I wrote about it the last time, as the stock was trading in line with my previous target price. Based on my current outlook and analysis of FIVE, I recommend a buy rating. Five recent performance disclosures have led me to become a lot more bullish. Growth momentum in 3Q23 has continued into 4Q23, which I believe has a good chance to follow through into FY24. Suppose management can continue to execute at this level; it should be able to achieve its FY26 guidance.
Review
I am briefly touching on FIVE 3Q23 results before I go into the 4Q23 performance (FIVE reported sales data regarding its 4Q23 quarter a few days ago). In 3Q23, net sales grew by 14.2% y/y to $736 million, and same-store sales [SSS] grew by 2.5% y/y. However, the decline in gross margin by 196bps to 30.3% resulted in operating deleverage, impacting EBIT margin by -106bps. EBIT margin came in at 2.2%, and EPS came in at $0.26. The strength seen in 3Q23 continued into 4Q23. FIVE pre-announced sales results for the period (Oct 29 to Jan 6), whereby net sales grew 15.6% to $1.16 billion, driven by 3.6% SSS growth. Based on this data, net sales accelerated by 140bps and SSS improved by 110bps. For FY23, management reiterated guidance that includes revenue of $3.54 billion to $3.57 billion, SSS growth of 2.5%, and EPS of $5.40-$5.56.
I will be focusing on the latest 4Q23 data and how it has impacted my outlook for FIVE. Touching on the SSS data first, the reported 3.6% SSS growth was really good, as it was an acceleration from the 2.5% we saw in 3Q23 and 0.9% in 4Q22. With that, management is now guiding 4Q23 to reach the high end of its guided SSS range (from a range of 2-3% to 3%). Since management noted that transactions and broad-based strength in performance across worlds drove the strong SSS performance, I believe the strong growth trend will continue for the rest of the quarter. The other part of the growth equation was very positive as well (store growth). So far into FY23, FIVE has already opened 204 net new stores, which is a big step up when compared to recent history. Management expects to open around 2000 more units by 2030, and within this guide, ~230 new units and ~260 new units are expected to open in FY25 and FY26. Translating this into percentage growth, it means that FIVE is expected to go row store count by mid-teens over the next two years. Combining that with the ~3% SSS growth, FIVE appears to be on track to continue to grow at least at the mid-teens level through FY26.
Thanks, Kristy. Now I'd like to update you on the Triple-Double strategy. As you recall, we shared the strategy with you back in March of 2022, and it was very simple. We were going to triple our stores by 2030, we're going to double our earnings and sales by 2026 -- 2025. Today I will update you on exactly where that vision stands. But in order to do that, I want to take a minute and look backwards at the last 5 years... And now I'd like to give you an update on exactly where we are with the Triple-Double as it stands today. As it relates to tripling our stores by 2030, I repeat, nothing has changed. We still expect significant store growth, and we expect to triple our stores by 2030. We opened 1,000 stores in the last seven years. We're going to open 2,000 stores in the next seven years. 2024 ICR conference
Given that the target to open 2000 stores by 2030 is a big step up in history, the question is whether FIVE can execute this plan. The encouraging news is that FIVE has been busy securing leases since the beginning of the year and is on track to return to its historical store opening cadence for FY24. FIVE’s new Five Beyond stores should be a growth tailwind in FY24, given that only 50% of the chain was new Five Beyond in 4Q23. These new stores take time to ramp up to maturity (typically 2 years before they reach the group’s level), and I expect the sequential improvements to support growth. In fact, I think there will be more room for FIVE to grow as it continues to focus on converting its chain to the Five Beyond format, aiming to reach 95% penetration by 2026. As Five Beyond becomes a larger slice of the pie, there might be some volatility in between the quarterly periods as these conversions would disrupt operations and also because of the duration needed to reach maturity at the Five Beyond store.
Valuation
Looking even farther ahead, management also provided an update on their long-term outlook (from the 2024 ICR conference):
- Open 2,000 stores over the next 7 years.
- Sales will double to $5.7 billion by FY26.
- Sales drivers: 15% unit growth and 2%–4% comp growth
- EPS will more than double to $10 by FY26.
- Operating margin: at least 12% over time
Author's work
Suppose FIVE is able to perform and meet management’s FY26 guidance; the upside is very attractive. As management has provided us with an expected EPS of $10 by FY26 (at the least), we can go back into the implied earnings growth. If FIVE does $10 in EPS in FY26, it implies ~27% earnings growth CAGR from the trailing 12-month EPS. The strong earnings CAGR is also the reason why I am expecting the stock to trade at 33x forward PE. When compared to peers, FIVE’s expected earnings growth CAGR is a lot better. For instance:
- Dollarama Inc. (22.2x forward PE) is expected by consensus to grow earnings at a low-teen CAGR.
- Dollar General's (18.3x forward PE) EPS is expected to be flattish.
Also, FIVE has the best debt profile when compared to peers. As of 3Q23, FIVE has a net debt to EBITDA ratio of ~2.1x, much better than the above peers of 2.2x and 3.3x, respectively.
From a historical perspective, FIVE is currently trading in between its historical average of 33x and the -1stdv of 27x. If FIVE can achieve its FY26 targets, I expect multiples to see a mean reversion.
Risk and final thoughts
The risk with investing in FIVE today is that the business might not be able to open as many stores as planned. As the guided number of new stores opening is a significant step up from the historical average, the execution risk is much higher. In addition, the macro backdrop could deteriorate to an even worse level, thereby impacting FIVE as consumers take a stricter stance in managing their wallet budget.
I am upgrading my rating from hold to buy. With robust same-store sales growth, an aggressive store expansion plan, and the continuation of conversion of Five Beyond stores, I expect FIVE to continue growing topline at least in the mid-teens range. If FIVE is able to achieve management FY26 guidance, I believe the upside is very attractive from the current share price level.
For further details see:
Five Below: I Turn Bullish On Management FY26 Targets (Rating Upgrade)