2023-06-21 06:59:17 ET
Summary
- Five Below has a strong business model and potential for continued store expansion, with a target of 3,500 stores by 2030 (<1500 currently).
- The company's financial performance is impressive, with revenue growth and margins outperforming industry averages, and resilient against economic conditions.
- However, FIVE stock is currently overvalued with a 20x+ EBITDA multiple, making it difficult to justify investment at its current price.
Investment thesis
Our current investment thesis is that Five Below, Inc. ( FIVE ) has a fantastic business model that will allow the company to continue its rapid store expansion. We believe its position is defensible and so growth will continue at >15% in the coming years. Relative to other retailers, the business looks fantastic. Margins are good and the business is resilient to economic conditions. The issue is that the company is far too expensive. With a 20x+ EBITDA multiple, we believe no alpha is available.
Company description
Five Below is a specialty value retailer operating in the United States. They offer a wide range of affordable products, including accessories like socks, sunglasses, jewelry, and cosmetics. They also provide personalized living space items and sports merchandise
Their goal is to offer a diverse selection of affordable products for everyday use, celebrations, and entertainment.
Share price
FIVE's share price performance has been strong in the last decade, driven by a consistent improvement in financial performance. This is against the backdrop of difficult trading conditions, reflecting what is a quality business.
Financial analysis
FIVE BELOW Financials (Tikr Terminal)
Presented above is FIVE's financial performance for the last decade.
Revenue & Commercial Factors
FIVE has grown revenue at a CAGR of 21% during the last 10 years, a highly impressive level for what is a mature industry. During this period, only two years saw revenue growth below 10% (both post-Covid), reflecting a resilience to the company's current trajectory.
Business model
The success of the business has been driven by its differing approach. The company targets a younger audience, and parents of these generations, selling a wide range of products at mainly the $1-$5 price range. FIVE's product focus is on brands where possible and always products with universal appeal, widening the breadth of reach. These are regularly refreshed, encouraging consumers to regularly check in for new items and allowing FIVE to respond to changing trends.
The company's slogan is "let go & have fun" and this is the aesthetic the business has built in its stores. Many discount retailers are bland in their store approach, focused purely on price and cutting costs elsewhere. This creates a perception of necessity whereas the customer relationship with FIVE is far more upbeat.
There are many other smaller factors implemented by Management but the overarching attitude is to be different from the traditional discounting model.
E-commerce
E-commerce continues to grow rapidly, causing a once-in-a-lifetime shift in the retail industry. The traditional brick-and-mortar ((BAM)) retailers have struggled due to the cost advantage these online-only businesses have, many of whom use supply chains from the far east. Further, online shopping offers fundamental benefits to consumers, namely convenience and the ability to easily shop around.
FIVE has been one of the few winners in this regard. The reason for this we believe is that BAM is not dead, the value proposition has just changed. In the case of FIVE, the constant rotation of stock, the price of its products relative to delivery costs, and the in-store experience are all factors that encourage people to shop in-store.
Further, the company has developed its own e-commerce offering, with a high-quality website that is easy to use and has all the classic upselling techniques that generate strong sales conversions.
Store expansion
Given the quality business model, FIVE has invested heavily in national expansion. During the last 10 years, the store count has grown 5x , with no evidence of a slowdown. Management intends to open a record 200+ new stores and complete over 400 conversions to the new Five Beyond prototype in 2023 (strong pipeline for 2024).
Management has an ambitious goal of opening 3500+ stores by 2030, which is over triple the current level. Based on the company's current trajectory, this looks achievable and should mean continued strong growth through inorganic means.
Economic & External Consideration
Current economic conditions are problematic for retailers. With high inflation and elevated rates, consumer spending is cooling in response to weakening finances. Our view is that FIVE should remain relatively robust during this period due to its current pricing model. Squeezed or not, consumers are unlikely to be priced out of $5 products.
Q1 results
Q1 results (Five Below)
FIVE's resilience is reflected in its most recent quarter, with comparable sales growth of 2.7%. During this period, the company opened 27 new stores. Based on market trends and data, Managements sees the business gaining market share and intend to exploit this further by expanding its store count.
This once again reflects the quality of the business model, with competitors currently unable to respond to what FIVE is offering the market. At least in the near term, the new store openings will be highly lucrative for the business.
Margins
FIVE currently has a GPM of 36%, EBITDA-M of 14%, and a NIM of 8%.
Margins have generally improved over the last decade, driven by the benefits of scale. The absolute improvements are slightly disappointing in our view, given revenue is almost 6x the size it was in FY14 with only c.1% gained in that period. We believe this is due to 3 key factors:
- The offsetting impact of stocking a growing number of products, restricting the ability to gain economies of scale.
- Inflationary pressures in its supply chain, which may now be subsiding as inflation declines.
- A focus by Management on maintaining strong growth, trading any margin wins to keep the pressure on its competitors and to gain market share.
Balance sheet
Inventory turnover has remained flat across the historical period, reflecting impressive stock management as the company expands. Our view is that a 4x level is strong and reflects healthy demand.
Despite the large investment in store count, FIVE utilizes no debt (Only leases on balance sheet in line with accounting requirements). This is overly conservative in our view, given we experienced a period of record low interest rates. Due to this, FIVE has utilized cash for capex, contributing to poor FCF generation and no material distributions.
Outlook
Outlook (Tikr Terminal)
Presented above is Wall Street's consensus view on the coming 5 years.
Analysts are forecasting a growth rate of 17% in the coming 5 years, almost wholly driven by new store growth. Management's 3,500 store target is very ambitious but it has the financial capabilities to deliver this. Therefore, the only real assessment is whether the demand is there. We cannot forecast the future but the current trajectory suggests so, and this is likely why analysts are forecasting such growth.
Margins are forecast to improve from FY25 onward, implying this will be driven in large part by a decline in input cost inflation.
Industry analysis
Retail Industry (Seeking Alpha)
Presented above is a comparison of FIVE's growth and profitability to the average of its industry, as defined by Seeking Alpha ( 33 companies).
As mentioned previously, the retail industry has struggled in the last decade, with further issues as a result of weakening economic conditions. This has allowed FIVE to completely outperform the industry average, and noticeably so.
The key areas of outperformance are forward revenue and EBITDA, which implies a relative superiority going forward. Further, Margins are substantially higher and so any slight dilution, or stagnation, is not diminishing its attractiveness in the industry materially.
Peer analysis
Specialist Retail peers (Tikr Terminal)
Given the substantial outperformance, we believe it's worthwhile quickly comparing FIVE to a select group of businesses, namely strongly performing Specialist retailers.
Comparing FIVE to this group still produces the same view of the business. FIVE a slightly better EBITDA-M while growing at a substantially higher level. Only BBWI has a higher margin but has seen growth slow and is forecast to trade flat.
Valuation
FIVE's differentiated business model, strong financial performance, and positive trajectory warrants a premium valuation. The issue with quantifying this is the lack of comparable businesses in the sector.
Valuation (Tikr Terminal)
When comparing FIVE's valuation to the peer group mentioned previously, FIVE looks incredibly expensive. It only has a 2% EBITDA-M advantage, which can be accounted for via a 10-20% multiple premium. The issue is that the growth element cannot be forecast with sufficient accuracy.
Valuation (2) (Tikr Terminal)
FIVE is currently trading at 21x NTM EBITDA and 26x LTM EBITDA. A 20x+ valuation is usually reserved for high-growth / highly profitable businesses. FIVE is neither in our view. Growth is extremely good but it comes at a large investment. Organic growth is only 2-3%.
Although relative valuations and deep analyses can be helpful, sometimes it is worth just taking a step back and considering a business from a market perspective. There are many businesses at 20x+ in a better relative position.
Analysts' 5Y EBITDA target implies a 5Y forward multiple of 11x, which is in the ballpark of its peer group when excluding Chewy ( CHWY ). Given the current stores due to be built plus the pipeline, we suspect the business will land close to the 5Y forecast on momentum alone. Given this, we believe it would be harsh to rate this stock a sell, given there is scope to outperform this.
Final thoughts
FIVE is a fantastic business. The company's ability to differentiate in a mature industry is commendable, especially when you factor in the business is doing so via "inferior" means (Brick and mortar).
We very much like the business model and believe competitors cannot easily respond to it. They can stock similar products but the stores will not have the same "feel" as a FIVE one.
With <1500 stores in the US, the scope for expansion remains strong. Management's 3,500 goal is optimistic but the runway is there. So long as demand remains strong, we see FIVE reaching this.
For a retailer, its other commercial factors are equally attractive. Margins are good and the company is resilient (thus far) against economic conditions.
The issue with FIVE is that it is far too expensive. A 20x+ multiple is difficult to justify in the retail industry, especially given the cost to achieve growth (<5% FCF-M).
For further details see:
Five Below: Quality Business Model But Uninvestable Valuation