- The massive negativity being thrown at Five Below is likely unwarranted.
- There do exist prevalent concerns going forward however, particularly if comps continue to slide.
- The trading strategy outlined below has generated out-sized annualized returns.
I have been following Five Below (NASDAQ:FIVE) for almost two years now, occasionally looking over the company's quarterly reports and management's projections going forward. Basically the business model has remained about the same and every now and then it has experienced small hiccups in the pipeline, but overall things remain intact.
After reviewing the market, some investors have developed three key drivers that they believe will make the stock price fall substantially:
1) Absurd valuation premium
2) Harsh competitive landscape
3) Continued comps deceleration
Yes, price to earnings, dfcf, price to sales, etc all make the company look expensive. So first I will start off with the valuation to explain why the market is pricing Five Below the way it is, while keeping this as simple as possible.
Let's take a look at almost any company's most valuable metric known as ROIC:
Clearly anything prior to May of 2013 was considered an anomaly for the company going forward. About 29% appears to be the normalized trend over the last year, which more than likely may see deceleration as the company moves into more competitive landscapes and/or non-core markets. Nevertheless, as I have mentioned in previous articles, having this metric above 25% is considered to be outstanding and very out of the norm. In most cases, we only see it in very high quality businesses like Autozone (NYSE:AZO), International Business Machines (NYSE:IBM), Priceline (NASDAQ:PCLN) and so forth. These companies have done very well in their corresponding industries and have seriously rewarded shareholders. Despite that Five's ev/ebitda previously looked outrageous it is coming back to earth, about in-line with other strong businesses:
A common mistake that investors make, and tend not to credit institutions with, is that financial modeling requires forward scaling to measure how the company may be worth in the grand scheme of things. Companies like Amazon looked ridiculously expensive decades ago but since its inception it has generated jaw-dropping returns.
In any event, for a DCF model, I applied the forward expectation of $1.17 with an implied 25% growth rate (slightly below estimations), input zero trailing growth and standardized discounting. By adding growth and terminal value, we reach a fair value of $42.30 pps.
Standard & Poor's IQ Capital happens to be much more bullish on the company's prospects citing a favorable cost structure and formidable differentiation versus traditional dollar stores, earning a premium peg ratio. The CFA also states that given a 57x multiple is applied to FY '15 eps of 90 cents, a price target of $51 is achieved.
Unfortunately I have never visited a Five store before, which practically undermines this section of the article heavily. But from what I have heard from friends is that the company does appear to have some differentiation, at least regarding the store layout in that it appeals to consumers much more than a traditional dollar store.
One figure that is useful here is sales per square foot for consumer traffic. I don't know the industry average off-hand, however I know Five runs a number around $250 where Family Dollar (NYSE:FDO) is closer to $180 or so. Given that top hedge funds have a vested interest in a company like FDO, one would think Five should be pretty attractive in this regard, citing a 38% net premium.
Same Store Sales
Comps have decelerated for this retailer quite aggressively from TTM backtracking the last four years. Realizing these corresponding levels, in this order: 15, 8, 7, 4. While the new realized 4% level in comps is concerning, it was more or less anticipated and a stabilization in the trend is predicted to take effect. As long as SSSG does not continue to decelerate, there is no motion for concern and the new store openings will support continued revenue growth for the company. Additionally, store openings have ramped up significantly this year at an estimated 62-65 stores versus previous years around ~50.
While the short float is not at a historical high, it still remains pretty elevated at 20%. Institutions and insider liquidation has also been noted over the last several months:
Chart provided by Finviz.com
Shareholder Value Concern
While the company has almost no debt to its name, the company has continued to offer multiple secondary offerings that have diluted shareholder value. I don't think any sane investor would view this favorably, unless he/she was a trader taking advantage of the short term price discrepancies related to the news. I am actually not aware as to why the company has been going through with this procedure given operating cash flows easily cover the company's capex. Perhaps it has something to do with the liquidations.
In previous articles I have mentioned that Five is a great company to trade given the whipsaw price action. A general rule of thumb is to buy support between $34-36 and sell any rips above $40 or so. This tends to have a very high success rate. Additionally, I also think the company is worth shorting above $50 pps (which I have done as well), but rarely does it reach this level.
I don't think it gets much easier than this: buy the green, sell the blue, short the red. Unfortunately as a TA, I'm not sure how long the price action will remain this way, but for now it's a swing traders' paradise. Buy the dip, sell the rip. Stochastics RSI is currently overbought and EWO just crossed above the zero point line.
A majority of investment banks and financial institutions remain bullish on Five Below citing continued strength in the core business, compelling growth going forward, and price targets ranging between $40 and $50 a share. In the last quarter, the company beat analyst expectations on both the top and bottom line, creating added bullish sentiment. I personally do not see massive downside risk from current prices, particularly at the consistent $36 support.