Five Below is a fast-growing retailer known for offering trendy, high-quality products at prices of $5 and below. Their product range spans eight categories: Style, Room, Sports, Tech, Create, Party, Candy, and New & Now. Founded in 2002 in Philadelphia, Five Below has expanded to 1,544 locations in 43 states as of February 2024. It operates primarily in the consumer discretionary sector, focusing on providing value-oriented merchandise targeted mainly at younger demographics, particularly teens and young adults. The company’s emphasis on affordable pricing and a broad product selection makes it a popular destination for value-conscious shoppers.
Five Below plans to expand its store base from 1,544 to over 3,500 locations across the U.S. They will focus on increasing store density in both existing and new markets to enhance brand awareness and operational efficiency. In fiscal 2024, Five Below intends to open 225 to 235 new stores, with each store averaging about 9,500 square feet. As of February 2024, they have secured leases for 137 new stores.
The store expansion has been achieved without incurring any debt. Alongside this growth, same-store sales have risen at a compound annual growth rate (CAGR) of approximately 4.5% over the past decade. In comparison, Dollar General and Dollar Tree (both considered gold standard among dollar stores) have reported same-store sales growth of 2% and 1.5% CAGR, respectively, during the same period. This suggests that Five Below is successfully increasing customer engagement and purchase frequency.
Five Below has managed to maintain its operating margins close to pre-pandemic levels, despite experiencing inflationary pressures in the past financial year. The decline in margins has been less severe compared to Dollar General and Dollar Tree. Five Below generally enjoys higher operating margins than other dollar stores because it operates primarily in the consumer discretionary sector, which typically offers higher margins than the consumer staples sector where Dollar General and Dollar Tree operate. Thing to note here is that, Five Below has been better at sustaining its margins as seen in the chart below. As the company continues to expand its store base, it is expected to achieve greater economies of scale and optimize its supply chain, further driving margin growth.
Stock performance
Five Below’s recent stock underperformance can be attributed to two key factors:
Management Shake-Up: The company is experiencing a significant leadership transition, with CEO Joel Anderson stepping down from his role and the Board of Directors. Kenneth Bull, the Chief Operating Officer, has been appointed as interim President and CEO, while Thomas Vellios, the Co-Founder and former CEO, will serve as Executive Chairman until a new CEO is appointed. These high-level changes have sparked concerns and speculation about potential underlying issues with the business, given that the company has only cited Anderson’s departure as him “pursuing other interests.”
Guidance Discrepancies: Five Below’s revenue forecast for the second quarter of 2024 is between $820 million and $826 million, marking an 8.4% increase from the $759 million reported in the same quarter of 2023. However, this estimate falls short of analysts’ expectations of $839.8 million. Additionally, the company’s guidance for EPS and net income has also missed analyst forecasts, contributing to the stock’s downward pressure.
Together, these factors—leadership changes and weaker-than-expected guidance—have led to a negative reaction in the stock price.
Current market trends and Economic condition
Deloitte’s financial report indicates that sentiment for discretionary spending is weak compared to 2021, with middle- and lower-income American consumers reporting little improvement in their financial situations over the past year. This weakness is particularly detrimental to Five Below, whose core customer base consists of lower-income consumers. As a result, the company has issued weaker guidance.
Five Below’s former CEO recently noted, “The lower-end customer is really being stretched. We’ve got to deliver value, and we’ve got to really display that in how we go to market, and when you walk in the store, what you see. But all that’s in flight right now, and [we] expect to see some of those changes improve by back half of the year.”
General consumer behavior in these conditions is to shift away from discretionary spending and more towards value-oriented purchases and staples which gives more value for buck. This is clearly reflected in recent Walmart’s earning beat and Five Below’s own revenue mix as well which saw increased sales of “Consumables” like candy, food, and beverages.
Source: https://www2.deloitte.com/us/en/insights/economy/consumer-pulse/state-of-the-us-consumer.html
Valuation
To assess the value of Five Below, I will examine it from both a pricing perspective—using price-to-earnings (P/E), EV-to-EBITDA ratios and based on future cash flows.
From a pricing standpoint, Five Below appears to be undervalued compared to other dollar stores, reflecting both current challenges within the company and broader headwinds in the consumer discretionary sector. Historically, Five Below’s P/E ratio has been around 40 in accordance with past growth rate of 20% cagr over the last 10 years. While current concerns about the company are overstated, I expect consumer discretionary spending should recover in the next year or so. I expect revenue growth for the next five years to be in the range 9%-11% cagr which should easily grant it a higher P/E ratio.
| P/E (TTM) | P/E (FWD) | EV/EBITDA (TTM) | EV/EBITDA (FWD) | |
| Five Below (FIVE) | 12.5 | 13.9 | 9.9 | 10.2 |
| Dollar General (DG) | 17.0 | 16.4 | 13.8 | 13.2 |
| Dollar Tree (DLTR) | 16.2 | 14.3 | 11.4 | 10.1 |
To determine the value based on discounted cash flow, I considered two scenarios. The bad-case scenario assumes Five Below is forced to scale back its growth target of 3,500 stores by 2030 and good-case scenario envisions the company achieving this target with improved margins resulting from better distribution.
Good-case scenario, implies revenue growth of 11% per year and operating margins improve to 12%, resulting in a discounted cash flow (DCF) value of $202 per share, with an implied annual upside of 19%. In the bad-case scenario, where company has to scale back its growth plans, its annual revenue growth is 9% instead and operating margins do not improve and remain at 10.5%. This leads to a DCF value of $149 per share, with an implied annual upside of 13%.
| Good case | Bad case | |
| Growth | Able to achieve 3500 stores by 2030. Revenue growth at 11% cagr | Has to scale back growth. Revenue growth at 9% cagr |
| Operating margin | Margin improvement to 12% by 2030 | No margin improvement. 10.5% |
| DCF Value ($ per share) | $202 | $149 |
| Implied Upside (% per annum) | 19% | 13% |
Other inputs for calculating DCF value:
Long-term growth – 3.8%
Re-investment based on sales-to-capital ratio of 3.0
WACC – 7.5%, Cost of Equity – 8.33%, Cost of Debt – 5.52%, beta – 1.10
Risks to Investment
Financial weakness in lower-income Americans could worsen and discretionary spending intentions among the American consumers could trend further down. Based on current stock price, the market thinks that not only Five Below will no longer be a high grower but it will not grow at all! Current stock price actually means that Five Below will only grow at 1% from now till perpetuity. Mr. Market has clearly overblown the negative sentiment.
Secondly, inflation may spike again which could erode profit margins. However, looking at how the company has managed to sustain its margins so far, I am not too concerned about this as I think management is equipped to handle this.
Conclusion
In conclusion, while Five Below is navigating a period of transition and external pressures, its long-term growth potential and current valuation present a compelling opportunity for investors. As the company adapts to evolving market conditions and continues to execute its expansion strategy, it may well capitalize on its strengths and return to a growth trajectory, offering promising returns for patient investors.
Disclaimer
The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice.