IPO Profile: Five Below
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Tech industry investors have learned recently that strong looking IPOs can flop spectacularly in the long-run (see: Zynga). But it isn’t just the digital debuts that should be examined with a cautious eye. Five Below (NASDAQ: FIVE), an entrant to the Specialty Retailer industry, debuted its IPO on July 19, raising $163 million on 9.6 million shares priced at $17. Five Below had raised its price from an initial range of $12 to $14 and still saw a 55% boost on its first day. Since IPO day, FIVE has seen a price range of $25 to $29.43.
Should you be on the lookout for Below?
The Corporate Bodies
David Schlessinger founded Five Below in 2002 and remains its chairman. Schlessinger founded a bookstore chain called Encore Books in the mid-90s, which later sold to Rite-Aid before becoming defunct, and then an educational toys line called Zany Brainy, which was sold to FAO Schwartz before becoming defunct. Many of Five Below’s key executives were part of Zany Brainy. The only executives with independent backgrounds in retail are CFO Kenneth Bull, who formerly worked for the teen-centric chain Urban Outfitters, and the newly hired General Merchandise Manager Lisa Surella, who worked at Wal-Mart and Lord & Taylor.
In 2010, buyout firm Advent International bought a controlling stake in Five Below. Advent, which also has its fingers in Lululemon and Charlotte Russe stores, is thought to hold up to 52% of the company. Five Below’s board contains two members from Advent, one from Charlotte Russe, and one from Staples.
The Stores
As the company name implies, products at Five Below cost $5 or less. Five Below differs from discount stores such as Dollar Tree (NASDAQ: DLTR) and Family Dollar (NYSE: FDO) in that it markets exclusively to pre-teen and teen shoppers. Stores feature over 4,000 trend driven products organized in a uniform way between stores, with a focus on flow and creative display techniques. Products are organized into eight categories:
- Sports: outdoor games, team gear, sports balls, water bottles…
- Media: headphones, paperback books, iPhone covers…
- Crafts: craft kits, school supplies, craft supplies…
- Party: novelty items, candles, party décor…
- Candy: movie theater candy, energy drinks, novelty edibles…
- Room: storage bins, décor, accessories…
- Style: clothing, jewelry, beauty items…
- Now: seasonal items updated throughout the year (currently summer themed)
There are currently 199 Five Below stores in 17 states; for comparison, Dollar Tree had 4,451 stores at the end of 2011 and Family Dollar had 7,267. The highest concentrations of Five Below stores are in Pennsylvania (48), New Jersey (32), Maryland (20), and West Virginia (18). Average square footage is 7,500 square feet. Most stores are in shopping centers but only 5% are in actual shopping malls. Five Below plans to open 50 new stores in fiscal 2012 and 60 in fiscal 2013. The long-term (20-years) goal is to end up with 2,000 stores in the United States.
Five Below has a model it expects newly opened stores to follow. New stores receive an average investment of $300,00 that’s expected to account for tenant allowances, inventory, and cash expenses. The store is then expected to earn $1.5 to $1.6 million in its first full fiscal year and achieve payback in less than a year.
The company is also planning to build a new distribution center before the end of next year. Nearly 90% of merchandise currently comes from one distribution center, located in Delaware.
Fundamentals
Net sales increased 58% between FY09 and FY10 ($125.1 to $197.2 million) and 51% from FY10 to FY11 ($197.2 to $297.1 million). Comparable store sales increased 15.6% in FY09-FY10 and 7.9% in FY10-FY11. The increases were due to more in-store transactions which generated marginal improvements in the average transaction value.
Gross profits rose 65% between FY09 and FY10 ($40.1 to $66.1 million) and 59% in FY10-FY11 ($66.1 to $104.9 million). Gross margins increased 180 basis points in the first period, with 166 of that due to purchase and store expense leveraging. Margins went up 150 basis points between FY10-FY11, 137 of which came from store expense leveraging.
Strengths/Weaknesses
Five Below’s greatest strength is its niche focus on a youth demographic. According to the 2010 US census, 17.6% of the population is between the ages of 5 and 17. That’s nearly 54 million potential customers. The problem is getting the stores to where the customers are located. Five Below is currently isolated to a relatively small geographic area. Expansion is necessary to increase the store’s reach.
Youth spending tends to be trend-driven, meaning that Five Below needs to be able to constantly update its merchandise. Five Below’s vendor arrangements facilitate this type of turn-over. The company works with over 700 vendors, the majority domestic, with no one vendor accounting for more than 8% of merchandise and no vendor having a long-term contract.
Buy “Below”?
Using the 2011 net sales of $297.1 million and the outstanding share average of 52.36 million, Five Below is currently trading at about 4x earnings. Competitors Dollar Tree and Family Dollar are trading at 2x and right on earnings, respectively. The current price for FIVE is too high considering large-scale growth is years down the line. If you’re in it for the long haul, wait either for a price drop down towards the original IPO range ($12 to $14) or for a corporate announcement that would fast-track the growth process.
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