I’ve been quite bullish on specialty retailer Five Below (FIVE) in the past. In the past couple of years, however, the valuation reached levels I didn’t see as reasonable, and my bullishness faded for that reason. Back in March, I recommended Five Below as a strong buy once more as the stock had fallen to $53, and I saw terrific long-term value at that price. Fast forward two months or so, and the stock has doubled. Given this, I think Five Below is back to being overvalued, and I think those among us that were fortunate enough to catch a double in the stock should take the proceeds.
The rebound looks somewhat uncertain
What has become clear in the past two months is that the rebound is going to be slow. Back in March, I personally thought we’d see a short shutdown, followed by a rather speedy return to normal. Obviously, that hasn’t worked out, and it has become clear that any sense of normalcy for our economy is a very long way off. That’s problematic for restaurants, movie theaters, and retailers that require foot traffic, among a host of others. Five Below needs traffic to generate revenue, so I’m much more concerned now than I was two months ago about its ability to come back the way it was before COVID-19.
Today, estimates for comparable sales show a 12% loss this year, followed by a 12% gain next year. Netting the two out implies that fiscal 2022 sales will be slightly below that of fiscal 2020, but it is close enough to say that Five Below should be back on some sort of normal track by next fiscal year.
However, keep in mind that also implies that there will be a string of three years where essentially no gains in comparable sales are made. That metric was slightly over flat in fiscal 2020, is slated to plummet this year, and should only make up lost ground next year. Whether we see -12% this year or +12% next year isn’t really the point. The point here is that Five Below is priced like a fast-growing stock, and while it continues to open lots of new stores, its comparable sales have been suffering and look to continue to do so.
Margins are another concern that I have for Five Below as it appears that we’ve seen the ceiling already at ~12% of revenue.
Above, we have year-over-year change for revenue, as well as earnings before taxes margin, or EBT margin, which is one way to measure operating income. Obviously, EBT margin will suffer this year but Five Below should remain solidly profitable, so no concerns there. But even after a massive upswing in revenue next year due to a full slate of store openings, as well as the comparable sales rebound, EBT margins don’t look set to recover even to former levels, let alone new highs. This has been the case since fiscal 2018, and I don’t see any catalysts that would alter this at the present time.
Five Below still has an outstanding balance sheet and a business model that works. I have no doubt the company will continue to expand its store base quickly and achieve its long-term store growth plans. However, with the uncertainty surrounding how people will return to retail stores and when, in addition the valuation, I think Five Below is a prime candidate for profit-taking.
The bottom line
Back in March, I saw extreme value in Five Below. I also thought at the time that shutdowns would be short-lived and that life would return to normal fairly quickly. Neither of those things became reality, and I cannot help but think that at least some long-term damage will be done to businesses that require foot traffic, as Five Below does.
Five Below has the advantage of being value-oriented, which will come in handy in the current economic situation where 40 million people are newly-unemployed. Value is king, and Five Below stands ready to meet that demand.
However, that has already been priced in according to what I see below.
Source: Seeking Alpha
Shares have doubled off of my buy call just two months ago, and trade for 29 times next year’s earnings. While I don’t think this is exorbitantly expensive given how quickly the company has grown earnings in the past, the fact is that the world has changed, and not for the better. Whether people return to stores the way they once did remains to be seen, but it appears to me Five Below has already priced in a return to normal, even though we’re a very long way from that being a certainty at this point.
At 29 times earnings, I see Five Below as fully valued, and given the risks inherent with any retailer today – Five Below included due to its reliance upon foot traffic – I don’t think full value is all that attractive to me. I cannot help but think there will be a chance to buy this stock lower in the relatively near future, and that there is very little potential upside in the valuation from here, so the stock should be sold.
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.