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Value Line has initiated coverage of Five Below, Inc. (FIVE) in its flagship product, The Value Line Investment Survey. The company is a rapidly growing specialty value retailer offering a broad range of “trend-right” merchandise targeted at the teen and pre-teen demographic. Owing to its name, all products are priced at $5 and below, with merchandise spanning style (novelty socks, sunglasses, jewelry, etc.), room (lamps, posters, blankets), sports (games, weights, toys), media (electronic accessories, books, video games), crafts (crayons, markers, school supplies), party (decorations, cards), candy, and seasonal (holiday-themed items) categories.

The company was founded in 2002 by Executive Chairman, David Schlessinger, and President and Chief Executive Officer, Thomas Vellios, and was incorporated in Pennsylvania in January, 2002 under Cheap Holdings, Inc. The name was then changed to Five Below later that year. In October, 2010, private equity company Advent International Corporation, acquired a majority interest in Five Below with the goal of supporting the management team in accelerating its growth. (Advent’s stake is now down to about 32%.) On July 24, 2012, Five Below conducted its IPO, with the company offering 4,807,692 shares of common stock at a price of $17.00 per share.

Since the first store opened in the greater Philadelphia area in 2002, the company has expanded across the Northeast, South, and Midwest regions of the U.S. and now operates 244 locations across 18 states. Stores typically feature over 4,000 stock-keeping units (SKUs) and average about 7,500 square feet located in power, community, and lifestyle shopping centers across a variety of urban, suburban, and semi-rural markets with a population of at least 100,000. Retail locations are designed to offer a unique and engaging in-store atmosphere and, while products are refreshed frequently, a consistent floor layout is maintained with an easy-to-navigate racetrack flow enabling customers to easily identify the different categories. Additionally, all stores feature a sound system playing trendy music throughout the shopping day and employ dynamic techniques to display products, including distinctive merchandise fixtures and colorful and stimulating signage, which attract customers, encourage hands-on interaction with products, and convey the company’s value pricing. In fiscal 2012 (years end the Saturday closest to January 31st), Five Below opened 52 stores, and had sales and net income of $418.8 million and $20 million, respectively.

The company competes with a broad range of retailers including discount, mass merchandise, grocery, drug, convenience, variety and other specialty stores; many of which have greater resources or brand recognition. Also, a lot of these retailers operate stores in some of the same areas as Five Below, and engage in extensive advertising and marketing efforts. The principal basis upon which it vies for customers is on price, store location, merchandise quality, assortment and presentation, in-stock consistency, and customer service.

In order to grow the top and bottom lines, Five Below plans to grow its store base, while driving comparable store sales, increasing brand awareness, and growing margins. The company believes there is a significant opportunity to expand its domestic store count from 244 locations to more than 2,000 over time. Based upon its strategy of store densification (which promotes brand awareness and leverages marketing, operating, and distribution costs) in existing markets and expanding into adjacent states and markets, the company believes most of its near-term growth will occur within its existing markets as well as contiguous new markets. When entering new markets Five Below employs a store clustering strategy, opening multiple stores in a single market on the same day, enabling it to leverage marketing and pre-opening expenses. This year, 60 net new stores are planned, with leases already executed on 51 locations. Comps should mainly be driven by increased brand awareness, resulting from cost-effective marketing strategies. Lastly, profitability gains will come from leveraging the cost structure as the company continues to increase its store base and drive its average net sales per store.

With the primary growth engine likely being its ability to open profitable new stores, investors should be aware of the factors that could affect this. The primary risks include the ability to identify suitable markets and sites for new stores; negotiating leases with acceptable terms; achieving brand awareness in new markets; efficiently sourcing and distributing additional merchandise; and generating sufficient levels of cash flow and financing to support expansion.

Moreover, the company must continue to stay on top of the latest trends to drive repeat customers. The success of its business depends in part on its ability to anticipate, identify, and respond promptly to evolving trends in demographics and consumer preferences, expectations, and needs. If Five Below is unable to do so then the top line could be hurt. This is most pertinent during the fiscal fourth quarter, which includes the holiday season, and typically comprises about 42% of total annual sales.

Additionally, as a value retailer, it is crucial that Five Below keep expenses down to maximize profitability. If the company is unable to continue to select products that are attractive to its customers, obtain such products at favorable costs, or to market such products effectively to consumers, its sales or profitability could decline. Expenses to operate the business will need to be kept in check, too.

Subscribers interested in this specialty value retailer are advised to consult Value Line’s quarterly reports, as well as any supplemental reports and relevant articles as important news items arise.

The author did not have positions in any of the companies mentioned at the time of this article’s writing.