As devastating as it may have been for most companies in recent history, the Great Recession actually served as a boon for discount stores. In particular, the effect was most clearly seen on those whose reputations incorporated the frugal nature of a monetary figure in their names. As seen in the chart below, specialty discount stores such as Dollar Tree Stores (DLTR) and Family Dollar Stores (FDO) took a sharp turn higher at the offset of the economic crisis shown in gray.
DG data by YCharts
One of the more recent additions to the variety discount store industry comes from a quickly growing store chain named Five Below (FIVE). The company offers various products priced at $5 and below. In July 2012 the company raised $163.5 million in its initial public offering of 9.6 million shares. Initially priced at $17, the company's shares quickly soared more than 50% on the first day's trading to over $28 due to the popular trend of discount stores. Nearly a year later, the company now trades at $36.98, expressing a 117% rise since its IPO.
Surging Past A Fair Valuation
But can all this be the consequence of mere investor euphoria in a trend that may not last? Industry leader Dollar General (DG) has in recent quarters been meeting expectations but has positioned itself to be more cautious in its outlook. In its latest quarter, the company met its earnings guidance but proceeded to cut its full year outlook citing slowing sales growth. Motley Fool contributor Sarfaraz Khan even suggests in an article found here that discount stores might be reaching a long-term saturation point in terms of growth. If proven to be the case, the valuation on the discount store peer group may begin to shrink.
In light of this, it's a wonder if Five Below is justified in its premium valuation based on its rapid growth to date. Investors have been excited to find a rapidly growing company that has widespread popularity with its customer base. Found in its Form S-1 filing, the company was expanding prior to going public with a compound annual growth rate of 37.2% as it increased its number of stores from 102 to 192 over the two years prior.
According to the latest earnings call, Five Below ended Q1 2013 with a total store count of 258. This came after the chain opened an additional 14 stores over the quarter. As a result of the store expansion, Five Below saw its revenues increase 33% from $71,829 to $95,604 from Q1 2012 to Q1 2013. The company also swung to a profit as it earned a net income of $1.54 million compared to a loss of $5.33 million.
Despite these significant gains, the company itself now stands valued with a market capitalization of $1.96 billion. Looking forward, the company carries a high price-to-earnings ratio of 40.20 on analyst estimates of $0.92 for 2014. The company also supports an above average Price/Earnings-to-Growth ratio of 1.73 suggesting that the company's growth has indeed been accounted for. Most surprisingly, the company's price-to-book ratio remains at an excessively high 25.93. A quick comparison with its discount peers in the table below suggests that the valuation of the company remains lofty.
|Name||Market Cap.||Fwd. P/E Ratio||PEG Ratio||Price/Book Ratio|
|Five Below||$1.96 Billion||40.20||1.73||25.93|
|Dollar General||$16.76 Billion||13.80||1.03||3.24|
|Family Dollar||$7.27 Billion||14.98||1.39||5.06|
|Dollar Tree||$10.99 Billion||15.02||0.95||6.35|
Lack Of Insider Confidence
Yet one of the greatest indicators of overvaluation has come from the officers, directors, and large owners of the company itself. Given the high price-to-book ratio, it would've made perfect sense for the company to leverage its elevated market price in order to fortify its balance sheet for the future. Yet rather than utilizing a secondary offering to raise funds for the company, insiders took the opportunity to sell out of their positions.
However the most surprising thing is that not only did these insiders take advantage of the high price in late January, but they repeated the process again in May. Not even a year old, and the company's management has found a method to exit their position en masse. Ironically, in a parting gift to shareholders, the strategy even increased the effective tax rate of the company as seen in the earnings transcript found here. Quoting the company's CFO, he states the following during the conference call:
"The increase in our effective tax rate was due primarily to permanent book to tax differences related to fees expected to be incurred for the secondary public offering in the second quarter."
Seen in the first offering in January, the numbers carried a lot of weight for a lack of insider confidence. Most notably, even co-founders David Schlessinger and Thomas Vellios took the opportunity to slash their holdings. They sold 852,281 shares and 845,166 shares respectively. According to the Form 4 filing, Executive Chairman Schlessinger now owned only 1,586,509 shares after the sale. Likewise, CEO Vellios only had 1,573,260 shares after the transaction according to his Form 4 found here. Pictured below is a selection of the insider sales associated with the first offering after the IPO.
There's no doubting that Five Below continues to gain significant ground when it comes to its rapid growth. The company is an excellent portrayal of a growing brand operating in an investor-friendly market. Yet for shareholders now, there does remain a need to question whether the company will be able to grow as quickly as its valuation suggests. The growth is clearly accounted for as the company trades at a premium now.
Some might argue that the company operates distinctly different from discount stores as its target customer base is focused more so on the teenage population. Yet it remains to be seen if the company can be disassociated with the popularized trend of discount shopping. Peers in the discount space continue to fair well although there remains possible signs that even this trend may be reaching a premium in the present.
Last of all, it remains disappointing to say the least that insiders continue to ditch their positions seemingly as fast as they can. It was already somewhat odd that the company would utilize a secondary offering as a means for such insiders leave their positions rather than for raising funds for the company. It was almost insulting that they would do it again prior to the company's first birthday as a public company. Overall, while Five Below remains an excellent company operationally, one has to wonder if the market's valuation has just far exceeded any fair notion of a proper assessment.