Five Below (FIVE) Initial Coverage

Core business, team & culture, opportunity, financials, valuation & target, and risks

May 01, 2021

Five Below is a discount retailer with a new concept offering trend-right products. With attractive unit economics and just over 1,000 locations, Five Below has a unique opportunity to reinvest capital at attractive rates.

Business Overview

“Five Below knows life is way better when you’re free to let go & have fun in an amazing experience filled with unlimited possibilities priced low, you can always say yes to the newest, coolest stuff.”

Founded in 2002 and headquartered in Philadelphia, Pennsylvania, Five Below is a high-growth value retailer targeting the tween and teens market.

Purchasing products in reaction to existing marketplace trends, Five Below focuses on trend-right, high-quality products for primarily under $5. The “Beyond Five” category allows for items at price points above $5. The company refers to the combination of quality and extreme value as the “wow factor.”

Stores are organized into 8 “awesome Five Below worlds”: Tech, Create, Play, Candy, Room, Style, Party, New & Now.

The differentiated, experiential shopping experience encourages consumers to “let go & have fun.” It seems to resonate with consumers, driving frequent and recurring purchases. On average, customers visit the stores 10 times per year, purchasing 60 items for a total spend of $150.

As of January 30, 2021, Five Below operated a total of 1,020 locations across 38 states. Five Below opened 120 net new stores in 2020 and plans on opening 170-180 new stores in 2021.

Five Below boasts attractive unit economics. A new store requires a net investment of roughly $300,000. With first year sales of roughly $2,000,000 and margins of 22.5%, these stores have a payback period of roughly 8 months. Management explicitly targets a payback period of under one year.

Five Below also sells merchandise online, through their e-commerce site fivebelow.com.

Management, Team, & Culture

Five Below is led by an experienced management team.

Tom Vellios and David Schlessinger founded Five Below in 2002. Tom Vellios served as Five Below’s CEO until 2014 when he transitioned to the Chairman of the Board. David Schlessinger served as the Executive Chairman until 2014 and ultimately stepped down from the board in December 2015.

Tom Vellios and David Schlessinger had experience working together. In 1991, Schlessinger had founded Zany Brainy, a retail store chain owned by FAO Schwarz that sold educational toys, with Tom Vellios as the CEO.

In 2014, Joel Anderson joined the team as CEO. He had previously been President and CEO of Walmart.com, based out of San Francisco. His prior experience includes roles at Lenox, Babies ‘R Us, and Toys ‘R Us. He received his bachelor’s from St. Olaf College in Northfield, Minnesota and his M.B.A. from Harvard Business School.

As of January 30, 2021, Five Below employed approximately 5,100 full-time and 13,900 part-time employees.

Culture is an important part of Five Below, as reflected in how they work, the Five Below way.

The company has well defined values and behaviors:

Wow our customers. The customer is everything, every decision we make begins and ends with them in mind. We do more than they expect and create an awesome experience they won’t find anywhere else.
Unleash your passion. Five Below is like a team of unstoppable superheroes. Everyone’s unique backgrounds and experiences blend together to form one incredible team that “bleeds five below blue.” We’re all pumped about what we do and all empowered to make a difference.
Hold the penny hostage. We’re on a mission to make everything as close to free as it can be for teens and tweens. When we pile up the pennies, we’re able to wow our customers with the most incredible must-haves and gotta-gets for $5 and below.
Achieve the impossible. We are Five Below; a one-of-a-kind experience! With our gutsy attitude and relentless drive to do better, we accomplish what others wouldn’t even think about trying. We take risks and win or lose as a team. Integrity always rules and coasting is never, ever an option.
Work hard, have fun, build a career. Anywhere you see the Five Below name something awesome is going on. People are succeeding, accomplishing impossible things, taking control of their future, helping their community, throwing a party or making friends. Face it, being the best is hard work, but all work and no play is not ok, so we live a little.

Opportunity

Five Below is targeting 1,200 locations by the end of 2021. Five Below has set a long term target of over 2,500 locations. Given that Dollar General and Dollar Tree have over 17,000 and 15,000 locations respectively, there seems to be room for more. The attractive unit economics provide a compelling opportunity for reinvestment over at least the next five years and likely longer.

Five Below’s low-cost operating philosophy, quick turnover, and rapid product iteration parallels shifts that have transformed other retail industries. In fashion, the rise of Zara and H&M, amongst others, have been very successful in transforming the clothing industry by focusing on these same ideas.

Discount retailers have proven to be resilient to the rise of e-commerce and the threat of Amazon. Five Below is further differentiated by the experiential shopping, giving teens and tweens a place to go. On average, consumers spend 20 minutes in the store per trip.

Constantly innovating, Five Below most recently launched self checkout in stores as well as same day shipping in partnership with Instacart.

Beyond their core business, Five Below is leveraging their positioning and expertise in adjacent opportunities. In October 2019, Five Below led the Nerd Street Gamers Series A financing round, investing $12 million in the e-sports company. Nerd Street Gamers has gone on to raise subsequent rounds, the latest of which was led by Peter Thiel’s Founder’s Fund.

Nerd Street Gamers operates gaming locations under the brand Localhost, https://www.localhost.gg/.

Nerd Street Gamers is focused on making esports accessible and available to all, as high performant equipment and robust internet connections required for competitive gaming can be expensive and out of reach for many.

Five Below’s core competencies - focus on teens & tweens, experiential offering, and affordability - line up very well with Nerd Street Gamers, allowing Five Below to contribute meaningfully to this partnership. Localhost locations would be connected to Five Below stores, driving natural synergies between the two. Five Below recently began working with esports influencers, in particular the 2019 Fortnite World Cup Champion, Bugha.

Financials

Revenue has been steadily increasing, rising from $419 million in February 2013 to over $1,962 million in January 2021. Although COVID interrupted operations, causing store closings over a few months, Five Below was still able to grow sales over 6% throughout 2020. As the economy reopens, sales growth is expected to return to the high teens or twenties.

Net income has tracked revenue growth, growing from $20 million in 2013 to $175 million in 2020. The most recent year’s release in January 2021 reported earnings of $123 million, reflecting the impact of COVID on the business.

As of March 2021, Five Below’s balance sheet shows $407 million in cash and equivalents. Five Below has $1,110 in outstanding obligations, all of which is for their operating leases. Five Below has no other long term debt.

Net margin has been consistent in the 5-10% range. However, the quick asset turnover allows for greater return. The company’s profitability ratios - return on assets, capital, and equity - have been consistently strong, with the exception of the most recent year due to impact from COVID.

Valuation & Target

Five Below’s stock has consistently moved up over time, including a quick recovery from the COVID shock in March of 2020. The market is currently pricing in the reopening of the economy, expecting fundamentals to bounce back as previously noted.

For the year ending January 2021, revenue came in at $1.96 billion with EBITDA of $224 million.

Consensus expectations for the year ending in January 2022 are $2.65 billion for revenue and $404.4 million for EBITDA, representing growth of 35% and 80% respectively,

As of April 27th, 2021, Five Below shares trade at $200.10, resulting in an enterprise value of $11.9 billion.

The stock currently trades at roughly 29x forward EBITDA.

Back-of-the-envelope calculations shows possible outcomes over the next five years.

If Five Below is able to grow EBITDA at a compound rate of 15% over the next five years and trade at a 25x multiple, the enterprise value could be expected to grow at a rate of roughly 11% per year. The table on the right shows how those returns would vary across growth rates and multiples.

An analysis of the intrinsic value, through a model projecting revenue, earnings, and free cash flow over the next ten years, yields a fair value assessment of today’s share price.

Two distinct methods were used to calculate the terminal value: exit multiple method and perpetuity method. With the discount rate set at 9%, the average of both methods yields a fair value price of roughly $210.

These calculations rely on certain key assumptions. Sensitivity analysis allows an investor to better understand the impact of any variations.

Risks & Catalysts

COVID disrupted the business in 2020, resulting in nationwide store closures. Given the interconnectedness of the global economy, supply chain issues could hamper innovation and delay time to market of particular items. Instability could occur for any myriad of reasons including countries being slow to recover from COVID, political reasons such as tariffs, or many more.

While discount stores have generally been resilient to e-commerce, there is a possibility that could change in the future. COVID may have changed habits and consumers may have gotten more comfortable placing even the smallest order online.

High inflation rates could be an issue for discount retailers, especially those holding prices under a particular dollar amount. As the name implies, Five Below targets items under $5. However, they have recently added the Five Beyond concept, giving them the optionality to extend beyond the $5 price tag.

As the economy reopens in the USA, there will likely be a much needed boost for retail stores generally. Five Below may be particularly well positioned, given their fun and hands on shopping experience.

Closing

Five Below brings a new concept to the retail market. The company has demonstrated market fit with their unique value proposition, namely:

Focusing on tween and teens
Trend-right, high quality merchandise
Low-cost items with exceptional value proposition
Differentiated shopping experience
Strong unit economics
Experienced management team

As an investment opportunity, Five Below possesses many desirable traits, including:

Durability: a proven concept with a long runway ahead coupled with demand is largely agnostic to the economic cycles, perhaps even fueled in a recessionary environment.
Growth and profitability: persistent revenue growth coupled with high returns on invested capital

The investment thesis centers on Five Below’s ability to grow and reinvest capital into attractive projects, compounding earnings over time. They have demonstrated this ability with expansion of their own stores as well as the exploration of adjacent opportunities such as esports.

While shares appear to be fairly valued at this time, double digit annualized returns seem feasible over the next five years. Patient investors could scale into a position over time, taking advantage of any market volatility. As always, investors should do their own due diligence before investing.

Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com
https://torrefinancial.substack.com

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