It's been a rough start to the year for the Retail Sector (XRT), with the index down 14% to start 2022. This has taken a bite out of sector leaders like Five Below (NASDAQ:FIVE), which has found itself down 28% from its highs, even after its recent bounce. Fortunately, for investors that were patient and didn't chase the stock in Q4, FIVE's valuation is now much more reasonable, with the stock sitting at a slight discount to its historical earnings multiple. Given the recent break of support, I am neutral short-term, but I would view any dips below $143.00 as low-risk buying opportunities.
Over two months ago, I wrote on Five Below, warning that the stock looked nearly fully priced heading into its Q3 results. This is because the stock was trading at more than 36x FY2022 earnings estimates vs. a historical earnings multiple of 37x trailing earnings. While the company posted blowout Q3 results, with revenue up 27% helped by mid-double-digit comp sales growth (14.8%), the stock immediately gave up its post-earnings gains, reversing to negative for the day despite the strong report. This suggests that while the company continues to fire on all cylinders, some of the beat may have been priced into the stock heading into the report.
Since then, the general market has come under pressure, the emergence of Omicron has put a minor dent in traffic trends for some retailers. This certainly hasn't helped the staffing situation, with a tight labor market exacerbated by some temporary team member exclusions related to COVID-19. Not surprisingly, this has put a dent in Five Below, which has found itself more than 25% off its highs at ~$237.00. This is a slight underperformance vs. the Retail Sector, which has slid 25%, buoyed by some luxury retailers like Signet (SIG), and grocery names, which have been temporary safe-havens from the market turbulence.
Just recently, however, Five Below surprised the market with the news that it didn't see much impact at all from a sales standpoint during the holidays. This was evidenced by the company reporting two-month sales of $870.9 million (October 31st to January 1st, 2022), which were up more than 20% year-over-year, helped by 7.7% comp sales growth and a meaningful increase in its store count. This comp sales growth rate of 7.7% lapped difficult comps of 10.1% in the year-ago period and translated to the company's highest 2-year comp sales growth rate during the holiday season since going public.
Five Below's CEO, Joel Anderson, noted that on-trend products like poppers and squishmallows helped drive some of the strength, with the toys & games world also performing very well quarter-to-date. From a staffing standpoint, the company's decision to roll out assisted self-checkout has paid off, which helped to offset staffing shortages and aided with distancing. It's worth noting that the roll-out of assisted self-checkout could help to reduce payroll hours slightly, helping to partially offset inflationary pressures. Meanwhile, it also helps to repurpose team members on registers to engage with customers, providing a better guest experience.
Finally, from an inventory standpoint, the critical seasonal items made it into the stores on time despite the supply chain headwinds, with Five Below prioritizing those items with a shorter shelf life (seasonal). This suggests that there will be limited inventory liabilities. Given the strong results, Five Below has guided for quarterly revenue of $995 million at the mid-point, which would translate to 16% growth on a year-over-year basis, an incredible feat after having to lap some benefit from government stimulus last January.
While this performance was solid, and Five Below continues to do an incredible job opening stores amid the pandemic (150+ year-to-date), Five Below still looks to be in the middle innings of its growth story. This is based on the fact that the company believes its long-term opportunity for stores sits at 2,500+, which is double where it expects to finish FY2021 (1,200+ stores). It's also worth noting that with Five Beyond exceeding expectations and products trialed at $25 price points seeing little pushback from customers, there is the opportunity to drive a higher average basket long-term.
A higher average basket would help boost comp sales. In fact, Five Below pointed out that customers that bought Five Beyond spent 2.5x the average, a very encouraging statistic. The possibility to sell a small mix of higher-priced items could help alleviate inflationary pressures when combined with a possible labor reduction from assisted self-checkout. This industry-leading unit growth combined with steady comp sales growth and investments to improve margins explains the company's impressive earnings trend below:
As the chart above shows, Five Below has grown earnings like a weed since FY2014, enjoying a compound annual EPS growth rate of ~27.7%, which dwarfs most other retail names (FY2021 estimates vs. FY2014). If we look ahead to FY2022 and FY2023, though, this growth is barely slowing down, with expectations for high double-digit annual EPS growth in FY2022 and FY2023. Notably, this is despite lapping a year that benefited from some government stimulus and the re-opening trade, which saw higher spending from some consumers after nearly nine months of lockdowns in 2020. Let's dig into Five Below's valuation and technical picture to see if this impressive growth story is worth buying after the recent correction:
As the chart below shows, Five Below has consistently been valued at a premium to its peer group, with the stock trading at an average earnings multiple of ~37 since going public in 2012. However, after the recent correction, the stock now trades at a discount to its historical earnings multiple, trading at just ~29.6x FY2022 earnings estimates, assuming it can meet or beat these forecasts. With some analyst estimates sitting closer to $6.00, a beat on FY2022 estimates would not be that surprising.
Even if we assume a more conservative earnings multiple of 30 to factor in the slight deceleration in the stock's compound annual EPS growth rate (~25.1% vs. ~27.7%), this would still translate to a fair value of $200.70 for its 18-month target price, based on FY2023 annual EPS estimates of $6.69. This points to more than 16% upside from current levels, especially if the company can beat these estimates. So, for investors that were patient to hold off buying above $200.00 per share when the stock was closer to fully valued, Five Below is worth keeping on one's watch-list, with the valuation becoming much more reasonable at current levels.
Moving over to Five Below's technical picture, we can see that the stock broke below a critical support level in January, which marked a new 1-year low for the stock. Typically, major support levels that are broken can often morph into new resistance, and with the $177.00 level broken, this could become a short-term resistance level. This has put a minor dent in the technical picture, with FIVE's reward/risk ratio, given that FIVE's next major support level sits 20% closer at $135.00.
Based on a current share price of $171.70, its current reward/risk ratio from a technical standpoint comes in at 0.15 to 1.0, which does make this an ideal buy-point on the chart. In fact, I generally prefer at least a 4.0 to 1.0 reward/risk ratio to enter new positions, and FIVE doesn't come anywhere near this criteria after its recent 15% rally. This doesn't mean that the stock can't go higher. Still, with a potential resistance level lying just overhead ($177.00 - $179.00) and the next support level sitting much lower, I remain on the sidelines, despite the improvement in the valuation.
With Five Below down more than 25% from its highs, many investors might be anxious to rush into the stock, and on a long-term basis, new entries at this level should pan out. However, with Five Below sitting just 3% shy of a potential resistance level (broken 1-year support), I remain neutral, with the unfavorable technical picture offsetting the significant improvement in the valuation following the sharp correction we've seen. Having said that, if Five Below were to dip below $143.00, where it would become medium-term oversold, I would view this as a low-risk buying opportunity.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.