Diving deeper into Five Below
There has been a trend with some of the biggest winners in my investing career...
As I said yesterday, they've usually come from the times when I've been able to purchase the stocks of great companies that encounter short-term (cyclical) difficulties that that market wrongly thinks are long-term (secular) issues and thus crush the stock.
I then shared a "first look" of one potential candidate: discount retailer Five Below (FIVE). The company is a great long-term growth story whose stock has been crushed – falling more than 60% since I warned my readers in my January 5 e-mail that it was overvalued.
As I showed in a number of charts, Five Below has grown revenue and earnings strongly over the past decade, generated consistent free cash flow, started to buy back shares, and maintained a strong balance sheet.
Today, let's take a deeper look at the company, what went wrong, and whether the stock might be a good buy...
Across approximately 1,600 small-box (roughly 9,500 square feet) stores, Five Below sells a range of inexpensive items – typically at prices below $5 (hence the name). This slide from the company's recent investor presentation shows many examples:
The company's target market is teens and tweens – most of whom don't have a lot of disposable income, so they're looking for bargains. The below slide from the presentation breaks it down:
As I showed in yesterday's e-mail, Five Below has been an exceptional performer – rooted in savvy merchandising and strong unit-level economics.
As this next slide from the presentation shows, the company now spends approximately $500,000 to open a store and it earns a full payback on that investment in only one year:
Lastly, Five Below sees a clear path to greatly expanding its store base by 2030. Here's the related slide from the presentation:
In light of these excellent financial metrics and strong historical and future expected growth, it's easy to see why the stock was a Wall Street darling. Back in early January when I mentioned it, analysts had been falling all over themselves to recommend the stock... even though it traded at 35 times expected earnings.
I warned my readers away from Five Below because, at that valuation, even the slightest hiccup can send a stock tumbling.
And that's exactly what happened...
The company's fall from grace began on March 20, when it reported fiscal 2023 fourth-quarter earnings that missed expectations due to "higher than anticipated shrink headwinds" – referring to losses from customer and employee theft.
At the time, Five Below gave guidance for the 2024 fiscal year of 0% to 3% same-store sales growth and earnings per share of $5.71 to $6.22.
The stock fell 15% the next day and continued to drift lower until the company released even more disappointing first-quarter earnings on June 5. While total sales were up 11.8% thanks to more than 200 new stores opening in the previous year, same-store sales declined by 2.3% and earnings were down as well.
This time, rather than shrink, then-CEO Joel Anderson blamed "the macro environment [which] disproportionately impacted our core lower income customers."
Worse yet, Five Below changed its guidance for the year to negative 3% to 5% same-store sales and took down earnings estimates by 13% to $4.97 to $5.37.
The stock fell another 11% the next day.
Finally, the coup de grâce came a week ago when Five Below announced that longtime CEO Anderson "has stepped down... to pursue other interests" and that the board would conduct "a comprehensive search for a permanent CEO."
This shocking news sent the stock crashing another 25% to $76.50 per share. (It closed yesterday at $78.87 per share.)
Not surprisingly, the Wall Street analysts who pumped the stock like crazy when it was above $200 per share are running for cover and now falling all over themselves to downgrade it. (I'll note that this can be a wonderful contrarian indicator, reflecting maximum pessimism, that I love to see in stocks I'm considering buying.)
So what happened to Five Below?
More important, from an investment perspective, are the dismal results a short-term, one-time hiccup – which would mean the stock is a screaming buy right now? Or are they signs that Five Below's model is broken – and the stock is therefore likely a value trap?
The company clearly took its eye off the ball as it relates to shrink, so that explanation rings true – and is a fixable problem.
And many retailers are reporting that low-income Americans are feeling pressure and cutting back on spending, so that rings true as well. Whether that will prove to be a short-term or long-term headwind remains to be seen... but unless we have a recession, the year-over-year comparables should look better, albeit not until next year.
For further insights, I turned to my friend and former colleague at my old firm Empire Financial Research, Berna Barshay, who's one of the smartest people I know in the retail space and is now writing for Wall Street Beats (here's her homepage there).
On Friday, she published a report on Five Below, which she kindly gave me permission to share excerpts with my readers. As she wrote:
The company has a tough comp against the Squishmallow trend – a type of stuffed toy that was red hot and peaked late last year, setting up for tough comps...
I am calling Squishmallows the second coming of the fidget spinner, because the FIVE shares got clobbered once before on a fad running out of steam. The stock went from around $135 to $90 back in the second half of 2018, when the fidget spinners went from tailwind to headwind.
And as she continued:
I went back to see what fidget spinners did to comps in their rise and fall. They took them from a baseline of 0% to 3% up to 8%-9% up for a few quarters, until they fell back to 3% when the fad died out. So there is precedent for one product making a huge difference.
It's a little tough to isolate the impact of the Squishmallow as they hit right at the end of a period of insanely inflated double-digit comps when FIVE was also recovering from the lockdowns and benefiting from stimulus checks. But we can see that the company was comping +2% to +3% when these toys were hot, and when they started to cool in Q1, comps flipped to -2%. A 5-point flip in comps when a trend slows has precedent from the fidget spinners.
But Berna thinks it's more than just tough comps from Squishmallows. Here's more from her on it:
But flipping comps into the negative, and more of a 10-point differential, does not have a precedent here. There has to be more going on here than just Squishmallows or the economy. And while the low-income consumer is clearly under pressure, FIVE should be getting some benefit from consumers going from Mattel or Hasbro to FIVE toys, or more expensive cosmetics and school supplies to the ones that FIVE sells.
One former longtime employee of the company told me they think the company has an issue with lack of fresh merchandise. Too much carryover product, and not enough new inspiration in the store. This sounds right on target to me.
As Berna continues, she thinks the problems are fixable:
They still have a great merchandising team, even if they may have lost a few players along the way...
The people I have spoken to think the company has underinvested in loss prevention and also shrunk store-level payroll way too much. This is fixable – but it will take time and money and be a headwind to margins for at least a year.
I agree with Berna that the problems look fixable and that the stock will likely do well from here, but I share her concerns that there may be another shoe to drop – as is often the case in situations like this – so the stock might have one more leg down. Here's how Berna put it:
I think the risk-reward is amazing here. I don't see the stock going under $60, which is only about 20% down from here... and I see a clear path to a double when they can improve operations... which I firmly believe they will do with time. This is still a great, fun store with a lot of blank space to conquer in the 50 states. All this argues to buy now.
But I think they could lower guidance one more time. I have no hard reason to believe this – no numbers, no channel check. It's just intuition on how these scenarios play out. I am hesitant to add until I know they won't miss again.
Thank you for sharing your insights, Berna!
In conclusion, I would also be hesitant to buy the stock today... but I would be keeping an eye on it.
Here at Stansberry Research, my team and I at our flagship Stansberry's Investment Advisory newsletter are going to do more in-depth research on Five Below.
If and when we think it's time to buy, our subscribers will be the first to know. If you aren't one already, you can learn how to sign up and take advantage of a 30-day money-back guarantee – and gain instant access to the current portfolio of open recommendations – by clicking here.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.