Three Crucial Details Regarding Five Below that You Should Explore Prior to Purchasing Shares

Three Crucial Details Regarding Five Below that You Should Explore Prior to Purchasing Shares

Five Below's (FIVE -5.60%) shares are on an upward trajectory. After hitting their 52-week low in August, they've witnessed a staggering 60% surge (as of the Dec. 12 close). The market sentiment is positive and the momentum is robust.

However, over the past five years, this retail company has experienced a 14% decrease, with a significant 51% decrease this year alone. If you're contemplating investing in Five Below, here are three crucial factors to consider:

Expansion of Stores

For any retail business, growing revenue from existing outlets, often measured by comparable sales, and expanding into new markets are crucial aspects of growth. In Five Below's case, the emphasis has been on the latter.

Following the opening of 82 new stores in fiscal 2024 Q3 (ending Nov. 2), the company now operates 1,749 stores nationwide. This figure is nearly double the count from five years ago. As a result, sales have increased by 124% during this period.

Given that each location generates over $2 million in sales and around $500,000 in adjusted EBITDA in the first year, with an average upfront investment of only $500,000, expanding into new markets makes good financial sense.

The company aims to have 3,500 stores by 2030. With ample opportunities for expansion in populated states like California, Texas, Florida, New York, and Pennsylvania, the potential for increased revenues is substantial if the expansion pace is maintained.

Strain on Key Performance Metrics

While Five Below's aggressive expansion strategy is boosting sales, it's also putting pressure on a few key performance indicators.

For instance, comparable sales only grew by 0.6% in Q3, marking an improvement after two consecutive quarters of decline. CFO Kristy Chipman noted during the August earnings call, "Customers remained selective with their discretionary spending."

This trend highlights the challenge Five Below faces in increasing sales at established locations. Additionally, negative comps are likely to reappear, with management projecting a 3% to 5% drop in same-store sales for the current quarter.

Profitability is also suffering due to higher labor costs. Five Below reported an operating loss of $0.6 million in the fiscal third quarter, contrasting with the $16.1 million operating income recorded in the same quarter the previous year. However, the leadership team slightly revised their profit forecast for fiscal 2024, indicating a return to profitability.

Five Below's Valuation

Despite Five Below's stock surge since mid-summer, it has underperformed the S&P 500 over the past decade. Given this underperformance, one might expect Five Below's valuation to be attractively priced, but that's not the case. As of now, the stock can be purchased at a P/E ratio of 21.4, only a 16% discount to the S&P 500 average.

While Five Below's potential turnaround might appeal to growth-focused retail investors, I believe the company needs to demonstrate concrete and sustainable improvements in its profitability and same-store sales before it becomes a viable investment option.

If you're interested in investing in the finance sector, Five Below's aggressive expansion strategy could be an intriguing opportunity. Despite opening over 800 new stores in the past five years, resulting in a 124% increase in sales, the company is currently facing challenges with key performance indicators such as comparable sales growth and profitability due to higher labor costs.

Given the current market sentiment and Five Below's 60% surge in share prices since August, it's crucial to consider the company's valuation. Although Five Below has underperformed the S&P 500 over the past decade, its stock is currently trading at a P/E ratio of 21.4, which is only a 16% discount to the average S&P 500 ratio. If you believe in Five Below's turnaround potential, investing in this finance-related retail company might be an interesting venture, but it's important to closely monitor its profitability and same-store sales improvements.

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