Five Below: Buy, But Buckle Up (NASDAQ:FIVE)
It’s a scary time to be a retailer. Amid shelter-in-place orders still in effect across all US states with a population of 4 million or more, most stores have gone completely dormant in the country.
Self-proclaimed “trend-right, high-quality extreme-value retailer for tweens, teens and beyond”, Five Below (NASDAQ:FIVE) is no exception. Although the company has maintained its e-commerce platform open for business, unlike other names in the retail space, a return to some sort of normalcy is probably still many weeks, if not months, away.
This sounds like a very bearish narrative for the company’s stock. But what has caught my attention is the fact that FIVE is still 26% below the late-February peak (after having dipped as much as 55% by March 19), and has been underperforming both the broad market (NYSEARCA:SPY) by quite a bit and even the retail sector (NYSEARCA:XRT) over the period.
Play defense now, grow later
I would not dare claim that the selloff has been unjustified. Five Below’s growth story, driven by aggressive footprint expansion and margin expansion opportunities in the longer term (i.e. gains of scale, phase-out of distribution center investments) has come to a screeching halt. While I have no good reason to believe that the retailer will be unable to get back on the growth path, a full recovery will likely happen only next year at best. For instance, the company’s new distribution center in the Midwest has been put on hold, and so have the capital investment plans for the remainder of 2020.
The good news is that I continue to see a market for trendy, inexpensive merchandise geared towards a younger crowd once the dust settles, a demand that I don’t believe names like Dollar General (NYSE:DG) and Dollar Tree (NASDAQ:DLTR) have been able to properly address in the past. Better yet, investors can jump onboard today and partake in what may eventually become a reborn, rare growth story in the brick-and-mortar retail space at a lower price. FIVE’s multiples have certainly recovered from March 2020 levels, but they continue to hover just above all-time lows, as the graph below illustrates.
For these reasons, my focus of attention turns not to Five Below’s ability to thrive in the immediate term, but rather to survive the challenging months ahead. In that regard, I believe the retailer will be able to hunker down and weather the storm just fine.
The graph below compares the company’s net cash position plus available revolver as of the end of 2019 against last year’s SG&A expenses. Certainly, looking at these two metrics only provides a rough estimate of how much Five Below might consume in resources if it were to stay dormant for a long period of time – i.e. no sales, no COGS, no inventory purchases, all other cash commitments halted. The answer is encouraging: about 8 months’ worth of liquidity. This back-of-the-envelope calculation assumes no government grants, additional loans or non-personnel cost savings.
Source: DM Martins Research, using data from company’s reports
Size FIVE appropriately in the portfolio
For the reasons mentioned above, I remain a FIVE bull for the long term. This is not to guarantee, however, that the stock will do just fine in the foreseeable future. Shares deserve their volatile designation within an already volatile sector, considering its growth profile. Therefore, investors who buy the stock should expect a bumpy ride.
This is why I choose to own FIVE in proportion to its risk characteristics. The stock has been a holding in my All-Equities Storm Resistant Growth portfolio for the past several months, but it is only the 13th largest among 22 positions. I believe risk-balancing my portfolio in this manner has worked quite well for as long as I have been managing it.
I use an approach that favors predictability of financial results and broad diversification when choosing stocks for my All-Equities Storm-Resistant Growth portfolio. So far, the small $229/year investment to become a member of the SRG community has lavishly paid off, as the chart below suggests. I invite you to click here and take advantage of the 14-day free trial today.
Disclosure: I am/we are long DG, FIVE. 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.