Five Below (NASDAQ:FIVE) stock surged nearly 7% in an otherwise ugly day for U.S. equities after reporting fourth quarter and fiscal 2015 earnings. This performance was somewhat surprising given that FIVE stock initially fell 5% in response to guidance that was fractionally lower than what analysts expected. Yet, the fact that FIVE typically guides light, almost always beats, and has some very bullish long-term goals all added in why FIVE stock created new 52-week highs on Wednesday. Particularly, Five Below management once more reiterated that it sees a clear path to creating 2,000 stores, and with that said, I'm looking at what 2,000 stores would mean to FIVE stock, thereby illustrating why the stock surged nearly 7% and will continue to create new highs.
First and foremost, I have been on the FIVE bandwagon for quite some time. Just before earnings I explained that Five Below is growing at a rate that is very similar to Dollar Tree (NASDAQ:DLTR) in the late 1990s, when DLTR was of similar size to Five Below today. In looking at three years worth of data, it is very clear that Five Below is on a very bullish trajectory that I conclude could push it to Dollar Tree-like size and scale long-term. That's why I told readers to buy FIVE stock just before earnings for the long haul, but more importantly, FIVE was one stock that I also told members of Tipping the Scale to purchase at the start of 2016 - FIVE stock is up 30% this year.
Nevertheless, if Five Below continues on its current and past trajectory it would take 20 years for it to become the next Dollar Tree in size. Furthermore, it would probably have to complete a series of acquisitions, like Dollar Tree did, to achieve such scale within the next two decades. Clearly, that's the long-term vision and potential, but if you are looking shorter term, say 5-7 years, then Five Below management's goal is a huge catalyst to operate 2,000 stores. If successful, which I assume it will be, then I ask the very simple question of what it means for the stock? In other words, where is FIVE stock headed over the next 5-7 years, versus my 20-year outlook.
The answer to that question is not as difficult as it may seem. Five Below achieved comparable sales growth of 3.4% last year, which means its revenue would have been slightly above $700 million for the full year versus $832 million had it not opened one store. So if we look at Five Below strictly from a comparable basis, removing the growth from store expansion, then Five Below earned roughly $1.91 million in revenue per existing store during this last year.
Seeing as how Five Below operates much larger stores than say Dollar Tree or Dollar General, it does not achieve the rapid same-store sales you might expect. But because its revenue per store is double that of most dollar stores, it does not need to grow fast on a comparable basis. Regardless, Five Below has maintained a rather impressive comparable store sales growth rate over the last five years, about 5% on average. I'm figuring that over the next seven years, that growth rate will reduce to 2% on average. If so, then Five Below revenue per store would rise to nearly $2.2 million.
Finally, if we assume that Five Below is successful in operating 2,000 stores by the end of 2022, and is creating $2.2 million per store, then its revenue would be $4.4 billion. That is significantly higher than the $832 million in revenue it earned last year on 437 total stores, and a reason to be very bullish.
With that said, Five Below is expanding at an incredible rate right now, upping its store count by 20% last year. Based on its outlook, that expansion is only going to intensify, unless it adds several 100 stores through a big acquisition, which is very possible. Given that it plans to maintain this expansion rate, I will assume that Five Below's operating income margin of 11% will be unchanged over the next seven years. But because revenue will be higher, Five Below will earn more than $480 million in operating income.
Currently, FIVE stock is trading at 24x last year's operating income. Even if that multiple reduces to 15x annual operating income, Five Below will still support a market capitalization of more than $7 billion by the time it reaches 2,000 stores, whether it be 5, 7, or 10 years. Specifically, a $7.2 billion market capitalization target represents upside of 220%, which even over a decade amounts to annual gains of more than 20%.
Given that I'm assuming no margin appreciation and for more than a third of FIVE's multiple to be wiped out, this target is not only attainable but also likely. In fact, even if Five Below never reaches 2,000 stores, and only operates 1,000 stores, the same math applies, and that annualized return from today's price would still amount to more than 10%. Collectively, it becomes very clear that Five Below is a must-own stock for the long haul. Yes, it will have some growing pains, possibly a really bad year or two over the next decade, but overall, FIVE stock will end up where it should, and that is much, much higher.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.