Five Below, Inc. (NASDAQ: FIVE) is growing rapidly thanks to its new store openings. New product offerings improve consumer satisfaction levels. The stock is significantly undervalued relative to its historical multiples. Peers with similar growth rates are trades at higher multiples.
Five Below is growing rapidly, mainly due to the successful growth of its number of stores. A new store brings the business an IRR of around 150% with a payback period of less than 8 months. The company has been able to record revenue growth of 23.1% thanks to the opening of new stores over the past decade. Management sees opening new stores as a good way to increase brand value and attract new buyers, so the target for the total number of stores has been revised upwards.
Management intends to reach 3,500 stores by 2030, indicating a CAGR of 14.5% in store count over an 8-year period. The new target is a substantial upward revision from the old target of 2,500. In 2021, the company opened 170 new stores in 24 states, as currently the brand has a presence in 40 US states (1,190 stores) . At the same time, the company is successfully increasing its comparable sales, with comp sales increasing 3.4% year-over-year in the fourth quarter of 2021 and recording a CAGR of 3.5% over the past decade.
The company actively invests in innovative solutions that can reduce costs and make the shopping experience more convenient. Associated Self-Checkout (ACO) solutions help the company reduce inflationary pressures from wage increases and enable it to improve the consumer experience. Five Below has already started using ACOs in 60% of its stores and plans to gradually increase this number to 100%.
The company’s CEO, Joel Anderson, expressed his opinion on the ACOs:
ACO empowers our team to move from the back of the register to the floor to assist our customers with their purchase and payment process, resulting in a better and faster customer experience.
The company is gradually expanding the product base offered. Management sees significant success in its Five Beyond offerings, as an average Five Beyond buyer spends 2.5 times more money than Five Below consumers. Thus, the number of stores where you can find Five Beyond deals is growing quite rapidly. In 2020, only 12.7% of stores offered Five Beyond products, while this number is expected to cross the 40% level in 2022 and the 60% level by 2024.
Du Pont Analysis
The company has a fairly high ROE margin of around 25%. Over the past 5 year period, the margin has improved from 21.7% to 24.9%.
The main driver for the improvement in ROE was the increase in net profit margin. In 2012, the margin was around 5%, while in 2021 it reached the level of 9.8%. At the same time, the asset turnover ratio decreased significantly from 2.2 to 0.99. Despite the decline, it should be noted that the ratio is not too low. Total leverage has increased significantly over the past decade; however, as the debt burden is low, it will not cause problems in the years to come.
Thus, Du-Pont’s analysis indicates that the company’s profitability is healthy.
It is also worth mentioning that the ROE margin far exceeds the required rate of return. Using the CAPM model (beta of 1.48, equity risk premium of 5.37% and risk-free rate of 2.4%), we obtain a required rate of return of 10.3%, which is clearly lower than the TTM ROE of 24.9% and even lower than the 2020 ROE of 14%. This means that management succeeds in creating shareholder value over a long-term horizon.
Like all brick-and-mortar retailers, the company faces significant risks from e-commerce vendors. E-commerce companies are gradually capturing market share from traditional retailers. Thus, the management must invest heavily to develop its own infrastructure for online shopping.
The company faces significant inflationary risks as it offers cheap products and cost increases can squeeze the company’s tight margins.
Over the past 10-year period, the stock has traded at an average P/S TTM multiple of 5.6, while the 5-year average is 3.8 and the 3-year average is 4.1. Currently, the stock is trading at a P/S TTM multiple of 3.1, indicating a below-average valuation.
To better understand the relationship between sales and market capitalization, we built a regression model of TTM earnings against market capitalizations. As a result, we find a strong correlation between the two variables since the R squared is equal to 84.9%. Given the analyst revenue estimate for 2022 of $3.24 billion and using the regression equation, we get an implied market capitalization of $17.37 billion, which is 95.8% higher than the current market capitalization.
Despite the decline in the P/S ratio, management was able to maintain a stable gross margin while improving the EBITDA margin. The 10-year average gross margin is 36.3%, while the TTM margin is 36.2%. The average EBITDA margin over 10 years is 14% against a TTM margin of 16.3%.
Regressing historical TTM gross earnings against market caps, we get a high correlation coefficient because the R-squared is 86.8%. Using an average gross margin of 35.2% over 3 years and an estimated revenue of $3.24 billion for 2022, we obtain an implied market capitalization of $13.4 billion, or 51% more than the current market capitalization.
Regressing historical EBITDA against historical market caps, we see a strong relationship, as the R-squared equals 81.1%. Using an average EBITDA margin of 13.7% over 3 years and an estimated revenue of $3.24 billion for 2022, we obtain an implied market capitalization of $11.86 billion, or 33, 7% more than the current market cap.
We also performed a comparable valuation analysis to assess FIVE’s valuation against its competitors.
As a result, we find that the company is valued quite conservatively. Using the data, we built a model regressing competitors’ FWD EBITDA (FY1) growth rates against TTM EV/EBITDA ratios. As a result, we get an implied EV/EBITDA multiple of 28, which is 32.3% higher than the current multiple.
We see a similar picture when we regress expected peer EPS growth rates (FY1) against P/E FWD multiples. Regression analysis yields an R-squared of 56.9% and an implied P/E FWD of 36.4 for Five Below. The result indicates that the stock has an upside potential of 23%.
Five Below has adopted a fairly successful business model and is achieving attractive growth. The increase in the number of stores and the growth in model sales could generate a CAGR of nearly 20% over the next decade. Our valuation analysis indicates that the stock is currently undervalued because, using the average of our valuation results, we arrive at an implied stock value of $239.4.
Our target price is almost 50% above the current market price. Thus, we believe the stock may be a good choice to outperform the market.