August 14, 2022

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Long term news

Five Below Has a Monster Opportunity

With revenue and net income that have increased at a compound annual rate of 25% and 33%, respectively, over the past decade, discount-store chain Five Below (NASDAQ: FIVE) hasn’t had a problem registering massive growth. And the stock has followed suit, rising nearly 400% since June of 2012.

This booming retailer, which had 1,190 stores across 40 states as of Jan. 29, has a big opportunity to bolster its e-commerce capabilities. Management emphasized this growth pillar at a recent investor day presentation, giving investors plenty to look forward to ahead.

shopping online from smartphone.

Image source: Getty Images.

Five Below can drive incremental sales

Not all physical retail is dead, and Five Below proves it. The business has rapidly expanded its store footprint over the past 10 years, which makes complete sense given the lucrative unit economics each location provides. The average Five Below store requires an upfront investment of $400,000, but generates $2.2 million in revenue and $550,000 in four-wall earnings before interest, taxes, depreciation, and amortization in the first year of operations. Opening stores as quickly as possible has been the right move.

Despite plans to triple the store count to 3,500 by 2030, management is focused on leaning heavily into digital in order to increase accessibility and convenience for shoppers. Five Below already has a mobile app, but in fiscal 2021 e-commerce sales represented less than 7% of the overall business, meaning that there is a sizable opportunity.

“Last year, we provided even more convenience for our customers by enabling same-day delivery in all of our markets,” Felipe Zardo, Senior Vice President of Digital, mentioned on the Q4 2021 earnings call. “And later this year,” he continued, “we’ll roll out ship-from-store in select locations and buy-online-pick-up-in-store across the entire chain.”

Bolstering the supply chain by investing $400 million over the past four years and partnering with third-party logistics providers should expand Five Below’s delivery capabilities in more markets. And this will make it easier for customers to get what they need in a timely manner.

The benefit of having a bigger e-commerce business is that it allows Five Below to engage more with its most loyal shoppers, which helps strengthen the brand and increase repeat purchases. At the same time, the company can collect huge amounts of data that can inform product and marketing initiatives.

From a financial perspective, online sales generally produce higher margins for a business. In fiscal 2021, Five Below’s gross margin of 36.2% and operating margin of 13.3% were already healthy. With e-commerce becoming a larger part of the company going forward as management hopes, margins should expand. These incremental sales should boost Five Below’s profitability, and ultimately its stock price, over time.

But this strategy has its drawbacks

While providing customers with an omnichannel experience by improving e-commerce capabilities has the possibility of being a boon for Five Below, it is not without risks. The most obvious, in my opinion, is that this move will put Five Below directly in competition with Amazon, which could be a losing proposition.

Five Below prides itself on offering an enhanced shopping experience as its stores employ vibrant, colorful layouts and a treasure-hunt environment that encourage browsing through aisles. Therefore, going to a physical location is part of the company’s value proposition. And because items are so cheap, primarily priced below $5, impulse purchases at stores can be an important source of revenue. How management balances the in-store experience that has propelled the business thus far with the online push over the next decade will be critical for shareholders to follow.

Additionally, Five Below currently charges a $5 delivery fee for online purchases, regardless of the basket size. The downside is that this fee might not be economical for consumers who are purchasing products that are already extremely inexpensive. On the plus side, people might be inclined to spend more in order to justify paying the delivery fee.

Even without a huge online presence, Five Below has proven its investment merits, which are more impressive given the struggle of many other brick-and-mortar retailers over the past decade. This is a quality business that has carved out a niche in a highly competitive industry, and I think the success will continue going forward.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Neil Patel has positions in Amazon and Five Below. The Motley Fool has positions in and recommends Amazon. The Motley Fool recommends Five Below. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.