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I’m Sorry, But the Five Below Stock Selloff Is Overdone

Luke Lango

Five Below (NASDAQ:FIVE) stock traded down in early June after the off-price retailer reported mixed first-quarter earnings that, at first glance, didn’t inspire much confidence from Five Below stock holders.

I'm Sorry, But the Five Below Stock Selloff Is Overdone

Source: Mike Mozart via Flickr (Modified)

Revenues topped expectations. But comparable sales growth fell short. The company is having to do many different things to offset the impact of tariffs, and consequently, the second quarter and full-year guides weren’t as good as they could’ve been.

In response, FIVE stock traded slightly lower, continuing what has been a month-long plunge in FIVE stock from $150 to below $120. In the big picture, Five Below’s first-quarter numbers were enough to confirm Five Below stock’s recent 20% drop is overdone.

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Despite the headline misses, Five Below’s numbers here are very good. Comparable sales were up 3.1%. The store count was up 19.9%. Net sales were up 23.1%. Gross margins expanded, even in the face of a 10% tariff on Chinese imports.

Management expects comparable sales to continue to rise in the low single-digit range for the foreseeable future, while the store base is expected to keep growing at a ~20% rate. Meanwhile, management is successfully side-stepping tariffs by passing along slight price hikes to consumers and renegotiating with vendors. Yep, Five Below is going to sell provides above $5.

That’s why (despite incorporating the new 25% tariff into their guide) management didn’t lower its 2019 numbers.

All in all, then, the story here remains rock solid.

Five Below is a rapidly expanding discount retailer that has found a winning strategy and is successfully mitigating the impact of tariffs.

That combination makes FIVE a winning retailer stock in a tough retail environment, meaning that recent weakness is an opportunity to buy Five Below shares at a hefty discount.

Five Below Stock Is Still Red-Hot

The story at Five Below is pretty simple to understand: As the name would imply, this is a discount retailer that sells items of all sorts for $5 or less (until now). It’s basically the dollar store, but at a roughly $5 price point.

The unique thing here is that Five Below constantly changes its inventory and offerings to match current trends. Think selfie sticks, spinners and the like.

This inventory flexibility gives Five Below low-cost exposure to all of retail’s hottest trends. That’s largely why this company has reported positive comps for the past several years.

Thus, Five Below has found a winning strategy (combining off-price retail with a flexible inventory), which has driven — and will continue to drive — positive comps.

On top of that, Five Below exited the first quarter of 2019 with only 789 stores. That’s a very small number. At scale, management thinks they can operate around 2,500 stores in the U.S. That’s why management is growing that store base at a fairly consistent 20% rate. Meanwhile, because comps are positive and new stores are performing well, margins are broadly stable and inching higher.

First-quarter earnings affirm that this favorable long-term growth narrative remains intact. Comps were positive … again. Five Below’s store base grew by ~20% … again. Gross margins expanded … again.

Importantly, all of that is largely projected to persist for the foreseeable future, despite tariffs, because management believes they can offset the tariff hit with slight price increases and renegotiated supply deals.

Overall, Five Below is a red-hot retail stock that remains a buy in the face of its earnings-related discount.

FIVE Stock Has Runway from Here

The opportunity in Five Below stock is that shares of the retailer have given back 20% over the past month on rising economic concerns.

Specifically, the entire retail sector was wiped out in May amid a slew of negative earnings reports, a drop in consumer confidence, and a rise in trade tensions.

As described above, though, Five Below is immune to most of that.

So long as Five Below’s business remains hot, then 20%-plus revenue and profit growth should persist. The store base continues to expand at a 20% rate. If that expansion rate persists, management won’t hit 2,500 stores until 2025.

During that stretch, comps should remain in positive territory because of this company’s off-price and flexible inventory strategy. Margins should also march higher as positive comps drive healthy operating leverage.

Bottom line, Five Below should easily grow the store base by 20% over the next several years, revenues in the 20% to 22% range, and profits in the 22%-plus range. Ultimately, that should drive per-share earnings toward at least $10 by fiscal 2025, if not higher.

High-quality retailers, like Walmart (NYSE:WMT), tend to trade around 20-times forward earnings. Based on that multiple, a reasonable fiscal 2024 price target for FIVE stock is $200. Thus, below $120 today, FIVE stock continues to have solid growth runway for the foreseeable future.

Bottom Line on Five Below Stock

Five Below is a winning retailer that has been unfairly punished alongside other retailers over the past several months. Healthy Q1 numbers should help turn the tide on investor sentiment. As that tide does turn over the next few weeks, FIVE stock should bounce back.

As of this writing, Luke Lango was long FIVE and WMT. 

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