Wal-Mart Should Buy Five Below

Discounting has been a tough racket for retailers now that the economy's showing signs of life. Folks still aren't frivolous with their money, but they don't mind trading up as much as they used to. This is naturally something that's been stinging Wal-Mart (NYSE: WMT  ) lately. The world's largest retailer has been posting negative comps more often than not in recent years, and that includes another year-over-year dip during this past holiday shopping season.

It was a crummy seasonally potent period for many retailers. Lousy weather and people embracing the convenience of online deals have caused traffic slumps across many leading chains. However, one of the few discounters that managed to squeeze out positive store-level performance was Five Below (NASDAQ: FIVE  ) .

True to its name, Five Below stocks items that it sells for $5 or less. It's not fair to lump Five Below in with dollar stores. Setting the ceiling at five bucks allows it to stock everything from shoes to sundresses to basketballs.

It's working. Shares of Five Below bucked the market's downward trend last week, soaring 11% after posting encouraging quarterly results. Sales jumped 22% in its latest quarter despite having one week less than the prior holiday quarter's 14-week period. Growth was fueled primarily by brisk expansion that saw its store count jump 25% to 304 locations over the past year, but a 0.3% uptick in same-store sales didn't hold it back. Five Below has historically been cranking out far healthier comps growth since going public at $17 two summers ago, but it's hard to complain about the deceleration when many discounters failed to surpass their prior year's store-level performances. 

Five Below would make an ideal buyout target for Wal-Mart. Five Below has the "cheap chic" appeal that Wal-Mart lacks, and adding Five Below "store in a store" locations inside its cavernous discounting havens would prove incremental to sales. If Wal-Mart would prefer to keep Five Below as a strictly stand-alone format, there's certainly no harm in that. Five Below stores are relatively cheap and easy to set up, and the company typically makes its investment back in the first year. 

There's plenty of real estate left to conquer. Five Below sees sales growth of 26% to 27% this new fiscal year, with adjusted earnings climbing slightly better than that. Wal-Mart's financial resources could accelerate the already ambitious expansion strategy, but the point here is ultimately about obtaining what it hasn't been able to secure on its own. Wal-Mart is cheap, but low prices can only take you so far. Wal-Mart doesn't resonate with teens and young adults, and that's where Five Below would fit in.

Five Below's stock isn't cheap. You don't deliver that kind of growth and remain in the shadows. However, it's better for Wal-Mart to overpay for a small chain that it can scale quickly than to keep missing out on the "cheap chic" trend. Wal-Mart and Five Below make sense.

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Rick Munarriz

Rick has been writing for Motley Fool since 1995 where he's a Consumer and Tech Stocks Specialist. Yes, that's a long time. He's been an analyst for Motley Fool Rule Breakers and a portfolio lead analyst for Motley Fool Supernova since each newsletter service's inception. He earned his BBA and MBA from the University of Miami, and he now lives a block from his alma mater.

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Related Tickers

8/27/2015 4:00 PM
FIVE $37.60 Up +1.44 +3.98%
Five Below CAPS Rating: **
WMT $66.08 Up +1.25 +1.93%
Wal-Mart Stores CAPS Rating: ***