per square foot, SG&A per square foot), FIVE’s metrics are quite poor compared to other dollar stores, and particularly poor when compared to large competitors such as Wal-Mart, Costco, etc.
Given that FIVE is a holiday-dependent retailer, its declining inventory turnover is particularly troubling. For example, for a retailer that sells household items and consumables (such as a CVS), the vast majority of their store-front sales are non-perishable inventory items. If a stick of makeup doesn’t sell in one quarter, it can often be sold in the next.
However, for a retailer that sells perishable items, or in FIVE’s case, holiday-dependent “seasonal” purchases, a lost sale may not be recovered, at least for an entire year. This heightens the risk of taking a significant loss on inventory. FIVE’s recent inventory trends look particularly troubling.
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FIVE’s Inventory Turnover is Falling, Which is Particularly Risky for a Holiday-Dependent Retailer |
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Declining inventory turns raises the danger of inventory obsolescence at FIVE, which would compress margins and further call into question the company’s 50x LTM P/E and 39x 2014E P/E multiples.
Highly Optimistic Discounted Cash Flow Analysis Implies 40% Downside
While we highlighted Five Below Inc (NASDAQ:FIVE)”s significant overvaluation relative to other retail companies, our highly optimistic DCF analysis further exposes FIVE’s current stock price vulnerability. Under our generous assumptions, we arrive at a share price of $23, 35% below where the stock closed on Friday. This valuation implies a more reasonable 11x 2014E EBITDA multiple, far below the current 20x multiple and in-line with high-growth retail stocks. Under this illustrative 10-year scenario, we assume that FIVE more than triples store count, quadruples revenue, and EBITDA and that SSSG stabilizes at 3.0% per annum. Our other assumptions include the following:
- Net new stores of 60 per year, 70 per year starting in 2018, 80 per year starting in 2022
- Gross margins of 35% and EBIT margins of 13% throughout projection period
- Maintenance capex growing at new store rate
- Store growth capex of $0.3 million per store
- Discount rate of 10%; terminal FCF growth rate of 3.0%
Even in our highly optimistic scenario where we project FIVE to grow revenue and EBITDA at a CAGR of 15%, the analysis reveals significant downside. Further, this scenario illustrates a best case scenario where FIVE has absolutely no missteps in growing store count, is able to manage volatility in sales of products that are inherently trendy, and executes its strategy to perfection. We believe that a tempered version of this scenario would further highlight FIVE’s current overvaluation and suggest even more downside.
Conclusion
In closing, we applaud Five Below Inc (NASDAQ:FIVE)”s management team for growing their concept to the current scale. However, we believe that the company’s market valuation is unjustified given the sharply declining SSSG trend, increasingly competitive discount retailer landscape, faddish nature of FIVE’s products, and its dependence on the holiday season. In light of these risks, and based on peer retail firms’ significantly lower valuations and our DCF analysis which suggests a much lower valuation, we believe that fair value is significantly below the current share price.
In future articles, we will discuss how many emerging retailers don’t live up to expectations, and how the retail landscape is littered with fast-growing concepts trading at 20x+ EBITDA in early years, only to see stock prices skid as execution issues, competition, cannibalization and limited total addressable markets lead to weakening sales per square foot trends, same store sales growth and margins in later years. We’ll also discuss how even some of the most successful concepts in the retail and restaurant sectors never traded at the lofty valuation multiples currently ascribed to Five Below.
