2023-10-05 12:27:33 ET
Summary
- Five Below has reported strong growth in comparable sales, demonstrating resilience in an inflationary climate.
- The company plans to open over 200 new stores in FY23, driving revenue higher and supporting growth.
- Despite challenges with inventory shrinkage, proactive inventory management is expected to offset setbacks. Hold rating recommended.
Investment action
Based on my current outlook and analysis on Five Below, Inc. ( FIVE ), I recommend a hold rating. FIVE has reported strong growth in comparable sales, a testament to its resilience even in an inflationary climate. This performance differentiates it from many competitors. Given FIVE's recent performance, I forecast revenue growth over the next two years to align with its historical benchmarks. While there are challenges, particularly concerning inventory shrinkage, the company's proactive inventory management is anticipated to offset these setbacks. Looking ahead, even though FIVE's future looks promising, its stock price currently trades at my target price.
Basic information
FIVE is a fast-growing American discount store chain that specializes in products priced at $5 or below. Aimed primarily at teens and pre-teens, the company offers a wide range of products spanning categories such as toys, beauty, candy, sports, tech accessories, and more. With its trendy and affordable product assortment, combined with a dynamic store environment, Five Below has positioned itself as a go-to destination for value-conscious consumers and those seeking a unique shopping experience. As the retail landscape evolves, FIVE continues to expand its store footprint, enhancing its brand presence and reach across various markets.
FIVE's historical annualized revenue growth rate stands at approximately 16%. However, in 2022, it dipped to around 8%. This decline can be attributed in part to lapping a challenging comparison from the previous year. Specifically, Five Below's revenue surged by an impressive 45% in 2021, driven by a mix of robust consumer demand and pent-up demand stemming from the COVID-19 pandemic. Given this exceptional growth in 2021, sustaining similar momentum in 2022 proved challenging. Hence, the annualized revenue growth rate offers a more accurate reflection of the real growth rate. For FY23, the company's revenue is projected to grow by approximately 16%, aligning with its historical average. Regarding EBITDA margin, it has consistently hovered at a rate of around 16%. This consistent performance underscores the company's effective cost management even as it continues to achieve double-digit growth rates.
Review
During the quarter, FIVE reported a 2.7% increase in comparable sales, fueled by a 4.5% growth in comparable transactions. This was slightly offset by a 1.8% drop in the average transaction value. It's noteworthy that the reduced average spend per transaction was due to fewer items being purchased, even though the average price of items saw a slight uptick. In today's inflationary climate, it's commendable that FIVE's growth in comparable sales is primarily driven by an increase in transactions and not just price hikes, which sets it apart from many other retailers. It's also promising to see that both new and existing customers are contributing to this growth. Considering the robust comparable sales performance, I expect comparable sales in future quarters to remain consistent with this quarter as inflation continues above the Fed’s 2% target, even though it is subsiding. This perspective aligns with the management's outlook. They forecast third quarter net sales to fall between $715 million and $730 million, factoring in the opening of around 70 new stores and predicting a roughly flat to 2% growth in comparable sales.
Following my analysis of its comparable sales, FIVE's expansion strategy provides further insights into their growth trajectory. The company is on course to inaugurate over 200 new stores in FY23. They have plans to introduce over 130 more in the latter half, with 70 scheduled for the third quarter. Management envisions an even distribution of store openings in FY24, split neatly between the two halves. It's noteworthy that FIVE has laid out robust plans for store launches in FY24 and years to follow. With a strong pipeline in new stores opening, I expect this to drive revenue higher as new stores are the key growth driver for the company.
“With nationwide potential of over 3,500 locations, new stores are the key growth driver for us and our new store economics remain industry-leading with a payback period under a year.” 2Q23 call
On another front, they've revamped nearly 400 stores to the latest Five Beyond design this year, amassing over 600 transformations since this design's debut in March of the previous year. As mentioned by management, converted stores bring meaningful increase in comp transactions. Therefore, I anticipate that the revamped stores will drive comps up, further supporting management’s positive guidance.
Transitioning from the topic of store conversions, another significant aspect to address is the inventory shrinks. These were discovered during the ongoing physical inventory check, which covers approximately a third of FIVE's stores. This notable increase in inventory shortfalls will likely affect the third quarter’s gross margin. The fourth quarter margin impact, on the other hand, is projected to be less pronounced. Despite these challenges, FIVE has adjusted their FY23 operating margin forecast to 11.1%. This adjustment considers the challenges arising from these inventory discrepancies but is offset by company-wide cost-saving measures and strategies to prevent further inventory discrepancies. If I were to look back at 2022, the operating margin stood at 11.2%. Essentially, management believes that the inventory shrinkage has little to no effect on its margins, thanks in part to the cost-saving measures and corrective actions taken.
Valuation
I believe that FIVE has the potential to grow by 16% over the next two years due to several factors. First, its results from the second quarter indicate robust growth in comparable sales, primarily fueled by strong comparable transactions. Despite the challenges posed by the high inflationary environment, the company's ability to grow reflects the resilience of its revenue model. Given the strong comparable sales, management has projected growth for both the third quarter comparable sales and the full year's revenue. Beyond robust comparable sales, FIVE is also aggressively expanding new stores and revamping existing stores. These two strategies are central to their growth plans. While inventory shrinkage is a concern, the company's efficient handling of inventory discrepancies is anticipated to mitigate potential losses. Consequently, I anticipate operating margin for the next 2 years to be consistent with its historical average.
FIVE is currently trading at ~14x forward EV/EBITDA. Its peers are trading at a median of 8.9x. Given that FIVE’s 35.6% gross margin is higher than peers median of 32%, higher 1 year expected growth rate of 21% vs. peer’s median of 9% and low D/E of 111 vs peer’s median of 286. I anticipate its multiple will expand to 16x, matching the upper range at which its peers are currently trading.
My price target for FIVE is ~ $155, closely aligned with its current trading price. Hence, I recommend a hold rating as there is no upside potential in FIVE's present share price. The risk of a valuation correction outweighs the advantages of retaining this otherwise commendable stock. Any deviation from the provided guidance could prompt a correction in the share price. However, given FIVE's robust financials, I wouldn't advise current investors to sell. Instead, they should consider purchasing more shares when they are available at a discount.
Risk and final thoughts
One potential upside risk to my analysis is that inflation could recover more quickly than anticipated, leading to a larger-than-expected rise in the average spend per transaction. This could yield stronger-than-forecasted comparable sales. When combined with FIVE's proactive approach to store expansion and revamp, this factor could further amplify the positive effect, potentially driving up the share price.
In conclusion, FIVE has shown strong comparable sales, primarily driven by comparable transactions. Its capacity to grow amidst an inflationary environment distinguishes it from competitors. Based on these impressive results, I foresee sustained growth in the upcoming quarters. I project revenue growth over the next two years to align with its historical average, a sentiment that echoes the management's growth forecasts for FY23. While the company grapples with inventory shrinkage challenges, I expect their proactive inventory management strategies to offset for any losses. Consequently, I anticipate future profit margins to stay consistent with historical trends, aligning with the management's outlook. Although FIVE's trajectory appears promising, its present share price has no upside potential. Thus, I recommend a hold rating.
For further details see:
Five Below: Robust Company Growth Outlook Overshadowed By Limited Valuation Upside