In 2018, I wondered if it was up, up, up in the case of Five Below, Inc. (NASDAQ:FIVE). During the 2010s, I have been appreciative of the discount retailer, but fearful given the premium valuation multiples applied to one of the most promising retail growth stories out there.
At the time, the company was combining solid organic growth with continued store openings, with the company defying some challenges faced by fellow (traditional) retailers. A focus on no frills, little legacy and fun shopping created efficient and desirable operations.
While the company has seen substantial growth ever since, the company is now plagued by shrink, a softer macroeconomic environment and self-inflicted price wounds, creating some concerns but real potential as well.
A Look Back To 2018
Five Below mostly sells items for $5, or less, focusing on younger customer cohorts with fun and flexible product categories related to sports, tech, creativity, seasonal items, style, candy and party items.
The company tripled the store count between 2012 and 2018, operating with some 750 stores, on average fetching just over $2 million in sales. With relatively modest investment per store and quick payback times, the company has been able to grow rapidly, with the company in the long haul targeting a 2,000-2,500 store footprint across the nation.
Around the time, the company guided for 2018 sales to come in around $1.5 billion, as I believed that the company might easily grow to $5 billion in sales in 2025, or around that time. With prevailing 12% operating margins, the company could post earnings around $8 per share at such a point.
With shares trading at $130 in 2018, that yielded a market multiple, if the company could deliver, however this multiple would be based on earnings seven years out into the future, which looked a bit demanding.
As earnings power was stuck around $2.50 per share in 2018, shares traded around 50 times prevailing earnings, far too high multiples based on the rosy expectations, at least that was my view. This left me leaning short, as while the business model was solid, the valuations had gotten a bit too demanding in my view, certainly for a non-ecommerce business.
A Growth Story, Cools Down
Since 2018, shares of Five Below have been doing alright as shares rose to the $200 mark in 2021, to trade at these levels again in 2023, and even as recent as March of this year. What followed was a relentless pullback in the share price recently, with shares back to $103 per share, having halved in just a quarter period of time. Shares are now down to the lowest levels since 2018 (if we exclude the turmoil around the pandemic), although that shares saw a somewhat similar dip in 2022.
If we look at the underlying results, we see that a $1.5 billion business in 2018 has come a long way to $5 billion in sales by 2025. The company had grown the business to more than $3.5 billion in sales by 2023, generated by just over 1,500 stores. This increased scale did not translate into higher margins, with inflation and depreciation expenses weighing on the profitability of the business. Operating margins have fallen from about 12% to 11% over this period of time, with exception to peak profits during the pandemic. Amidst a flattish share count, earnings advanced to $5.41 per share in 2023, as a $200 stock still translated into a demanding earnings multiple in the mid-thirties.
The fortune in the stock changed on March 20 of this year, when the company posted its 2023 results, a year in which revenues rose by 16%. This was driven by a near 3% increase in comparable sales, with store openings still being the dominant driver of overall sales growth.
The issue was with the outlook for 2024, with Five Below seeing comparable sales growth for the year come in between flat and positive 3%. With 225-235 store openings, the company sees sales increase to $3.97-$4.07 billion, with overall sales seen up around 13%. Problematic is the volatility in earnings, seen up to $5.71-$6.22 per share, at the midpoint up by around 10%. Flattish comparable sales growth in an inflationary environment was lackluster, and triggered a sell-off to the $170s overnight.
Coming Down Further
Following the release of the 2024 outlook, shares have kept on falling in a rather gradual move, as shares fell to the $120 mark upon the release of the first quarter results early in June.
While first quarter sales rose by nearly 12% to $812 million, comparable sales were down just over 2% on the year before. This created quite some operating deleverage on the business model, with operating margins down 140 basis points to 4.4% of sales, as earnings fell by ten cents to $0.57 per share, with adjusted earnings posted at $0.60 per share.
The company trimmed the full-year sales guidance by roughly $200 million, equal to 5%, with sales now seen just between $3.79 and $3.87 billion, with comparable sales seen down 3-5%. This is weighing on profitability, with adjusted earnings now seen between $5.00 and $5.40 per share, suggesting negative profit growth, as this was the news which killed the growth story entirely.
The huge and continued shortfall in the results is attributable to softness in macroeconomic conditions, certainly among lower-income cohorts, with no quick avail in sight. Moreover, shrink, or more bluntly theft, remains a growing and persistent issue.
Expectations Have Been Reset
Since March, shares have been cut in half, with shares down to $103 per share, as actually some fundamental appeal is found here. Long traded at a 40-50 times earnings multiple, expectations have come down to about 20 times earnings, while the balance sheet strength prevails, although free cash flow needs are still huge amidst store openings being planned.
The chain, which claims to offer hot stuff and cool prices, might as well have reversed its mission recently. Its share price has been hot in the past and prices have not cooled, as the company priced in the shrink loss, making some sales declines self-inflicted, with its clientele battered by inflation.
The theft argument surprises me somewhat, although this was mentioned in recent quarters as well. After all, many of these items come in at $5 or less, meaning that thieves will have to go through a lot of trouble to make some money on stolen items, or “save” money directly. More so, depending on the outcome of the election and political environment, the company is very susceptible to trade wars, potentially tariffs, as it is a massive importer from China, of course.
On the other hand, the company is still profitable, has a great track record, and could double its footprint in terms of stores in the coming decade, as solid execution might simply extend the growth story to the 2030s.
Putting this balancing act together, now is likely the time to get more upbeat on the shares, as valuation look more reasonable based on subpar profits in 2024. The issue, however, is that of poor execution, as there are definitely some cracks in the growth story, either self-inflicted and in part attributed to macro conditions as well.
At best, I might be willing to hold a speculative position in the shares at a level sub $100. However, right now, right here, I fail to have conviction to initiate a position in size here, as after all, this is a retail business trading at a market multiple here.
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