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Is Five Below Stock a Buy?

By John Ballard – Sep 15, 2021 at 9:00AM

Key Points

  • The company continues to open distribution centers pointing to long-term growth.
  • The recent back-to-school season highlights Five Below's advantage in shifting inventory to meet demand and grow sales.
  • Five Below could more than double its store base over the long term.

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This hot retail stock recently sold off over disappointing sales performance.

Five Below's (FIVE 0.22%) stock price is down 14% since it reported its fiscal second-quarter earnings results at the beginning of September. While sales growth clocked in at a strong 52% year over year, the reported $646.6 million in net sales was lower than the consensus analyst estimate, which called for $657.8 million. 

The knee-jerk reaction over the recent earning results provides investors a good opportunity to buy shares. Five Below's strategy of selling trendy products at low prices has translated to a track record of market-beating returns. Management continues to focus on investing for long-term growth by expanding fulfillment capacity and opening more stores.

Here are three reasons investors should buy the dip.

A Five Below employee helping a child shop for candy in a store.

Image source: Five Below.

1. Mapping the country with distribution centers

Besides the sales miss in the last quarter, Wall Street is concerned about rising transportation costs affecting Five Below's profitability in the near term. Management reported freight costs started to increase toward the end of the fiscal second quarter and expects those costs to remain high through the end of the year. Analysts estimate Five Below will report adjusted earnings per share of $0.29 in the current period, down from $0.36 last year. 

The concerns around the recent sales miss and new cost pressures are short term in nature and shouldn't concern long-term investors. Five Below is continuing to open new distribution centers around the U.S. At the end of 2020, Five Below had four distribution centers and one e-commerce fulfillment center. It just opened a new distribution center in Arizona with another in Indiana planned to open in 2022.

These distribution centers shorten the delivery route to stores and should ease the impact of transportation costs on the bottom line. Most importantly, investors should look at these investments as a forward indicator of store growth and higher customer demand, which ultimately increases the value of the business.

2. Adaptable inventory strategy

Five Below isn't a discount retailer of just candy and trinkets. The company has been expanding its Five Beyond assortment, a category of select goods the company sells above the $5 price point. 

Five Beyond is a tool to attract new customers. It also shows Five Below's potential to target any trend to drive higher sales. For example, during the back-to-school season, the company was able to source a range of apparel items, including denim jackets, flannel shirts, and backpacks, and it's contributed to a strong start to the current quarter. 

Management is calling for sales to be up approximately 17% year over year in the fiscal third quarter at the midpoint of the guidance range. Currently, about 270 stores feature Five Beyond products, and management expects 30% of the store base to offer these products by the end of the year and 50% by the end of fiscal 2022.

3. Long-term growth potential

Five Below ended the fiscal second quarter with 1,121 stores open across 39 states. It's continuing to invest in improvements to the in-store experience to drive higher repeat sales, including assisted self-checkout options and new e-commerce capabilities. Five Below recently expanded its partnership with Instacart to offer same-day delivery across the store fleet. "We believe our presence on Instacart is an effective brand awareness and new customer acquisition tool as well as a convenient service for our customers," CEO Joel Anderson said during the second-quarter earnings call.

Management sees plenty of areas in the U.S. to open more stores. It is targeting more than 2,500 locations long term, and new stores earn a rapid payback on opening costs within one year. This has fueled the company's net profit growth of 304% cumulatively over the last five years. 

With an experienced management team behind the wheel, this is a retail stock that has all the ingredients for market-beating gains over the long term. 

John Ballard has no position in any of the stocks mentioned. The Motley Fool recommends Five Below and recommends the following options: long January 2022 $115 calls on Five Below and short January 2022 $120 calls on Five Below. The Motley Fool has a disclosure policy.

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