Five Below (FIVE): Fallen angel; Solid growth; Profitable; Excellent FCF; Recent price crash

KEY TAKEAWAYS

FIVE is a value retailer offering trendy products under $5, with recent additions over $5. Over the last decade, sales grew more than 5X, consistently generating profit. The store count rose from 366 in FY 2014 to 1,544 in FY 2023. The company generates significant free cash flow, which it uses to fuel growth CAPEX for store expansion and distribution centers. With a strong balance sheet and zero debt, FIVE has significant growth prospects.

However, in the last few months, the stock price fell more than 65% due to recent quarterly profitability issues and decreased revenue projections, largely driven by challenges in the low-income demographic. Additionally, the abrupt resignation of the company's long-time CEO and several downgrades from research firms have further impacted the stock.

Despite trading at a depressed valuation, FIVE has a long runway for growth. Given its excellent free cash flow generation in the past, the company has the potential to revive its financial performance when the economy improves.

 RESEARCH

1. Value retailer

• The company is a value retailer offering trendy, high-quality products for tweens, teens, and beyond, with most items priced at $5 and below.
• Five Below distinguishes itself in the discount retail market by offering a mix of essential items and trendy, discretionary products. The store caters to a younger audience by stocking popular items such as Squishmallows, Funko toys, and fidget spinners, combining practical needs with the latest fads.
• Products at Five Below stores do change rapidly, and you won't find leftover products from previous trends.
• The company's new store model is approximately 9,500 square feet, featuring over 4,000 products across various categories.
• Suggested further readings
• https://www.washingtonpost.com/business/2018/12/28/five-below-is-wonderland-things-no-one-needs-its-also-one-most-successful-retailers-america/
• https://medium.com/swlh/why-five-below-is-beating-other-discount-stores-at-the-retail-game-6c0857cbbe3f

 2. Profitable, solid growth and generates FCF

• Solid growth of stores

-        The number of stores increased by 4.2 times, from 366 in FY 2014 to 1,544 in FY 2023. 

• Solid financials

-        The company's sales grew by more than 5X in the last 10 years and has consistently generated profit.

• Solid FCF

 3. Five Beyond format store

• Since 2018, the company has been discussing selling products over $5 and implemented a trial run in 2019 in a few stores by selling products priced between $5 and $10. In 2020, the company named this business initiative "Five Beyond" and executed the strategy in 140 stores, expanding it to 250 stores in 2022. During fiscal 2023, the company converted a significant 450 stores, making it 700 stores – 50% of the total stores.
• As of the recent conference call (Q1 2024), the company had converted 60% of its stores to the "Five Beyond" model and expects to reach 80% by the end of the year. Interestingly, according to the Q1 2024 conference call, the vast majority, or about 85%, of the units sold are priced at or below $5.
• The company observed that customers who buy a "Five Beyond" item (defined as $6 and above) continue to spend over twice as much as those who buy only "Five Below" items.

WHY ARE WE FLAGGING THIS? & COMMENTARY

Stock price crash

Within the last five months, the company's stock price has crashed over 65%. In the past five years, the company traded below $70 only during the onset of the pandemic. This is the second time the company is trading around $70.

Why?

1.      For the quarter ended Q1 2024, the company's comparable sales decreased by 2.3% and it projects a 3% to 5% decrease in comparable sales for fiscal 2024. The company noted that it experienced underperformance in the lower-income demographic due to inflation.

2.      The company's operating income declined by approximately 15%.

3.      Reduction in outlook:

-        The company projects a 3% to 5% decrease in comparable sales and

-        Lowers the upper end of its fiscal 2024 revenue expectation to $3.87 billion from the previous $4.07 billion.

4.      Most recently, the company initiated a pricing test in about 100 stores to measure the impact of price reductions on driving sales.

5.      Adding to the company's challenges, its long-term CEO resigned abruptly and joined Petco as CEO.

6.      Several research firms downgraded the stock following these developments.

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 Valuation

M.Cap: $3.9 billion

Debt: Nil

Cash: $369 million

EV: $3.53 billion

Revenue (2024 E): $3.87 billion

EV/Revenue (2024 E): 0.9X

 Note: Operating lease is ignored

Even though Five Below may seem appropriately priced when compared to Dollar General and Dollar Tree, it is important to note that Five Below is growing rapidly and still has a significant runway for expansion. In contrast, Dollar General and Dollar Tree have experienced stagnant revenues.