T.J. Maxx, Ollie's Discount Outlet, and Costco have made treasure hunting a big part of their appeal. Consumers don't know what they'll find when they come in, and that drives repeat visits. That's a model that has also worked for Five Below (FIVE -0.03%), a different take on that model aimed at teenagers and younger people.
A full transcript follows the video.
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This video was recorded on Feb. 12, 2019.
Dylan Lewis: If listeners haven't caught on at this point, we're using Toys R Us as an example here to talk about a lot of companies that are doing things very well in the retail space. One name that we haven't talked about, but I think absolutely deserves mention here, is Five Below.
Dan Kline: I love Five Below! Five Below is growing super rapidly. I'm not a dollar store guy, and Five Below has managed to straddle that line where it has, say, semidisposable headphones that I know I'm going to break a million pairs, I'm going to lose them, I buy them for my son because he has no ability to not chew on his headphones and destroy them. That's something you'll learn when you have kids someday. But also, you might find weird Japanese candy or a defunct flavor of soda that they bought all of, or a T-shirt that you could wear to paint the house because it costs $3. It's a really smart business model based on having a core value of certain items where you know you can always get, I don't know, a big box of Junior Mints at a cheap price, and headsets and minor accessories, lightning cables, things like that. And you never know, maybe today there'll be yoga mats, maybe there'll be kickballs, maybe there'll be costume jewelry. It's a really fun model and it's exploding.
I think we both marveled online that they claim -- and we didn't verify this -- that their average store buildout takes eight months to pay itself off. That's not a number other companies ever report because usually it's three to five years. That's a tremendous sign that this concept is very expandable. They added 53 stores in the last quarter, and they're growing pretty much as fast as can be.
Lewis: Yeah, it's been a wildly successful concept. What's kind of funny to me is, they've been around for quite some time. This stock has only recently caught up to a lot of the major investments they're making in their footprint. You look at this business, they're posting 20% year-over-year growth. Pretty incredible for someone in the retail space. A lot of that coming from the new stores they're opening. I think their comps number is closer to 3% or 4%.
Kline: I think this story is a lot like Dollar General, which I've talked about on the show before. Investors are so hung up on same-store sales they don't look at the fact that when your top selling price is $5, there's somewhat going to be a max for what your store reaches. What's interesting about Five Below is that they very quickly can ramp up to that number, they can eke out a little bit -- 2%, 3%, 4% -- of same-store growth, but they can open another store five miles down the road, or six or whatever the exact number is, and do the same thing, because it's not a store you're really going to travel for, but it's a store that draws very well wherever it is.
Another very important thing that makes this an attractive stock is Five Below doesn't need to be in super expensive retail. It's a destination on its own. Most of the ones that I've been to -- and I've been to maybe five or six of them -- are in secondary strip malls. They're not even always at -- if it's a Target strip mall, maybe they're really far away from Target, so you have to move your car to get there. That holds their costs down. It's also sort of like a big strip mall store, but not a big-box store, so their costs are also very well-constrained.
Lewis: You were talking a little bit about the opportunity when you're selling everything at $5 and below. Management is also experimenting with this $10 and below concept. It's clear they're interested in iterating on this idea. I think that at its core, they're providing a store experience that's really fun for kids, too. At $5 or $10, most kids can go in with their holiday money, their birthday money, maybe their allowance or something like that, and feel like they can buy most things in the store, which is fun for kids.
Kline: We talked about how I used to bribe my son with a trip to Toys R Us. Now I bribe him with a trip to Five Below. I could say, "You have a budget of $5," and he could buy two things -- a candy, a soda, a little electronic gizmo. There's a lot of selection and a lot of fun. One of the things kids really like is having control. When you're under 16, you don't get to make very many of your own decisions. What you eat is controlled, some of what you wear is dependent upon your parents. So walking into a store where, for a pretty limited amount of money, I can give you a lot of choices, that concept resonates really well.
Lewis: I was looking at the Five Below story, Dan, as we were doing the prep for this show, and admittedly it wasn't a name I was super familiar with. But I started seeing all these metrics and I was like, "Wow, 20% year-over-year revenue growth, opening a lot of stores, that payback period on the stores that they're building is really strong." I think what makes retail investing so tough, though, is the concept is a winner, but the stock is trading at like 55 times trailing earnings, which is expensive for retail stock.
Kline: It is. But I think you have to look at this -- I don't want to say this is an internet-proof concept, but I've used some of those websites where you could buy dollar items and they show up three weeks later. And then, when it arrives, you're like, "Why did I buy a dollar laser pointer that doesn't work? Why did I buy a stylus for my iPad?" There's an instant gratification of the Five Below model, and I don't think that's going to go away. I think we've seen with Costco that people are willing to walk into a store and make sort of dumb impulse purchases. With Costco, maybe that makes you more careful in the future. If you're spending $3 stupidly, are you really going to change that habit? It's really a price of admission that's well worth it even if you make dumb purchases every time.