Description

1-Year Price Target - $134 74% upside

BUSINESS DESCRIPTION

Five Below is a specialty value retailer that was founded to sell items for $5 and below. More recently the company has added a small amount of space in some locations selling items for $10 and below as a way to provide more value for customers and to try and benefit comps as well as to help offset tariff issues in the short-term

The typical store is 8,500 square feet and sells items that fit into what FIVE calls their eight worlds, “Style, Room, Sports, Tech, Create, Party, Candy and Now”. The store is built around parents being able to say yes to their kids when they grab something, because everything is very low priced parents can easily say yes to a kid when they ask to have something, where at a Target that toy may be $50 or $100 dollars it is always affordable at FIVE. The company has very low capital costs when opening a location and scales very rapidly due to their location selection. As such they generate IRRs of 150% (they quote 150%, I calculate 161%) and under one-year payback periods.

With a store base of ~900 locations as of YE2019 I believe there is long-term potential to have perhaps 5,000 or 10,000 locations. Dollar Tree one of their closest competitors has 7,500 locations under the Dollar Tree banner and 7,800 under the Family Dollar banner. The stores have broad customer appeal. Supporting my belief, they can expand significantly. They are currently in only 36 states.

Recent Events:

• Through March 11th (39 days into the quarter) the company had been comping +2.9%, through March 17th the company was comping 0.4% for the year (45 days into the quarter). Simple math implies that comps were about -15.8% for those 6 days.

• On March 19th the company announced they were closing all of their stores across the country and currently their website notes they expect to stay closed until May 1st unless the situation changes. As such the company is going to generate zero revenue for the second half of the quarter implying the company will probably generate around 50% of the typical amount of sales for 1Q21.

• This implies revenues of about $180-200mm in the quarter, gross profits of $60-70mm and likely -$10-20mm EBIT

•  D&A for the Q is likely $15mm therefore it is likely cash was -$5mm to +$5mm outside moves in NWC (which likely helped given they source from china and supply chains have been impacted)

• The company still has their online store open however this is a miniscule portion of the business and cannot be counted on picking up any slack.

Coronavirus

• The company generates ~60% of annual EBIT in Q4 it is important for the business to be open and operating in Q4. Currently the store is closed during a moderately less valuable time period. 

• If the recession becomes more normal with the economy open but still suffering, the value orientation of FIVE could help relative to purchases at TGT and other higher priced stores.

• The company has a strong balance sheet. They ended Q4 with $262mm of cash and short-term investments. The company has a $50mm line of credit that they haven’t drawn on as well. Yielding at least $312mm of liquidity.

• Given store closures and fewer hours it is reasonable to believe the company will be able to save significantly on SG&A. The company spent $442mm in FY19 on SG&A with the quarterly cadence being ($95mm, $110, $106, $145). It is reasonable to assume cost cuts across every quarter and much lower costs due to reduced hours (reduced to zero).

• Cash burn per quarter

o   DRAG: SG&A – $75mm (reduced level)

o   DRAG: Capex – reduced capex $10mm

o   BENEFIT: D&A – $15mm

o   Net shift: $70mm in losses per quarter

o   Amount of cash $260mm

o   FIVE can survive for 3.7 quarter without significant cuts to expenses, zero revenues, no capital raises, assuming no online revenues or inventory close-outs to generate cash.

§  I am fairly certain we will not be in a situation of zero revenues for this long, as such FIVE can survive this downturn and while it may take out weaker competitors it will leave a more open store location landscape for FIVE and likely lower rents improving the overall business.

INVESTMENT THESIS

Store Growth: The company has a target of 20% store growth for the foreseeable future. Given their direct competitors operate ~15,000 each (DG and DLTR) 5,000 to 10,000 long-term appears reasonable.  FIVE has only 900 and many people are still unaware of the company; this is a very fair assumption. In addition, the company has not seen declining IRRs as they expanded from the east coast to the west coast.

The company currently targets 2,500+ stores but this is likely to rise over-time.

Great IRR: FIVE generates 150% IRRs on their new stores yielding an 8-month cash payback period. This yields the company an ability to grow stores without using significant outside capital. In fact, the company has a net cash position excluding leases.

Smart Management: FIVE has a management team that is focused on improving the concept. Unlike DLTR they did not need an activist to motivate them to look at breaking their $5 and under target and expanding to ten and under in order to potentially broaden the TAM. The management team is also conservative with their cash using only net cash for buybacks recognizing they are in the growth mode and want to be safe. FIVE was incubated within Zany Brany an East coast toy retailer that went bankrupt about 20 years ago. The CEO knows the dangers of debt and is prudently managing the business setting them up well for the current environment.

Valuation: Coronavirus has pummeled the B&M retail space and sent FIVE down to prices not seen since late 2017, early 2018. To value FIVE I value the company on an individual store under a normal basis. Each store is worth $3.3mm assuming an 8% discount rate, 2% LT comps, 11x FCF, $2.1 million-year 1 store revenues. Given the current store base of ~945 that is likely at the end of 1Q20 the business would be worth $3.1 billion today with no future store growth potential. Add in the net cash and investments $260mm and the current bear case value of the business is $3.37 bn, 3% below the current price.

PRINCIPAL INVESTMENT RISKS

• Consumer behavior: Post corona if consumers avoid B&M stores it is possible that FIVE comps and revenues per box will never reach prior heights. Half of their store traffic is from other shopping trips, if consumers reduce B&M visits FIVE will suffer.

• Corona: If corona keeps stores shut for a very long-time the company may impair value through firing employees and closing stores which could damage the fair value in the short and long-term.

• Competition: DollarTree is not closed and they are currently breaking the buck. It is possible that DLTR will become a better competitor to FIVE and hurt their business. In addition, the concept is highly profitable, perhaps it will draw competition, although it hasn’t really yet.

• Online: Online is not a major competitor as of yet given my estimate of the typical purchase generating in the range of $3.50 to $7.00 of gross profit. Given delivery costs are in the $4-6 range this would east up all of the profitability. In addition, consumers head there for convenience to get something now and/or they do not have something in mind. Currently online doesn’t solve these use cases.

RECOMMENDATION AND PRICE TARGET

• Target price: Target = $134 in 12 months, 74% upside. 5-year price target of $182 discounted back 4 years at 8%.

Catalyst

Stores re-open

Company reports cotninued revneue growth

Company restarts share repurchase