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Five Below: A Growth Gem Weighed Down by Temporary Headwinds
Stock Analysis & Ideas

Five Below: A Growth Gem Weighed Down by Temporary Headwinds

Story Highlights

Five Below is a well-run discount retailer that’s still in the early innings of its growth story. Inflation and supply-side issues have weighed heavily in recent quarters. However, as such headwinds pass in the second half, it’s Five Below that could be the first of physical retailers to find their footing again.

Shares of discount retailer Five Below (FIVE) haven’t been spared from the broader market sell-off. FIVE got pummelled, shedding around half of its value before a 22% recovery rally to $139 and change per share. On the one hand, Five Below is being punished because it’s a relatively high-multiple growth stock in a rising-rate world. On the other hand, Five Below is a discount retailer that sells most of its goods at or below $5.

However, it is worth mentioning that inflation has pressured the company to increase prices for more premium products to as high as $25. Indeed, Five Below no longer sells everything for below five dollars. In any case, customers have responded relatively well to items priced at $6 and above.

At the end of the day, it’s a discount retailer’s job to offer customers the best possible value and relative assurance on prices. A majority of items are still below the $5 mark. Although this number is likely to fall as inflation’s effects work their course over the coming years.

In any case, Five Below is still a standout retailer that offers growth in the retail segment at a fairly reasonable price. At writing, shares of FIVE trade at 29.5x trailing earnings (indicative of a growth stock) and 2.7x sales.

Both multiples are still above and beyond that of the retail industry average. Still, Five Below has shown it’s more than worthy of a premium price tag for its long-term growth prospects.

As inflation pressures fade, we could enter a period of mild economic contraction. Such an environment could allow Five Below to shine and perhaps regain some of the ground lost over the past year. I am bullish on FIVE stock.

Interestingly, however, FIVE has a 6 out of 10 Smart Score rating on TipRanks. This metric indicates that the stock is likely to perform in line with the broader market, going forward.

Five Below Hit by Inflation, but It Won’t Last Forever

Five Below aims to pass value to its loyal customers. Still, the company has struggled to absorb the impact of high inflation. With COVID-19-induced supply-chain struggles, Five Below has been hit with a perfect storm. Still, such headwinds could fade as soon as the second half, and I don’t think you can fault management for succumbing to environmental pressures that seem to have negatively affected almost every firm these days.

The main reason to own Five Below over its peers, though, is its compelling expansion strategy. The company hasn’t just been quick to expand into new geographies; it’s been very prudent at only expanding into markets capable of offering a great return for its buck.

In short, Five Below does its homework before opening up new stores in uncharted waters. It’s this disciplined expansion strategy that’s allowed the firm to maintain relatively impressive operating margins (12.4%) versus the retail industry average (around 10%).

As inflation’s impact works its course while supply chains normalize, I’d look for management to have more success in passing on higher costs to consumers. It’s the higher-margin goods that could propel operating margins much higher from current levels.

The consumer isn’t all too happy to pay more for less. In the meantime, its budget-friendly retailers like Five Below that could be the first of the retail names to rise. Cost certainty is in high demand these days.

Looking further out, Five Below faces increasing competitive pressure from digital retailers, most notably Amazon (AMZN), which is increasing its selection of lower-cost goods. Indeed, it’s tough to compete in retail when the retail behemoth is looking to expand its disruptive wings across all corners of retail.

In any case, Five Below has an improving e-commerce platform, and various technologies have helped reduce friction at the checkout counter.

Wall Street’s Take on FIVE Stock

Turning to Wall Street, FIVE stock comes in as a Strong Buy. Out of 20 analyst ratings, there are 16 Buys and four Holds.

The average Five Below price target is $167.84, implying upside potential of 20.6%. Analyst price targets range from a low of $115.00 per share to a high of $216.00 per share.

Conclusion: Five Below is in Good Shape

Five Below may wish to consider changing its name to Six Below after the inclusion of higher-priced items. As the company irons out the inflation and supply-side wrinkles, I’d look for such higher-priced items to apply upward pressure on margins. In the meantime, the company is in good hands while it looks to make it through the worst of the inflation storm.

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