Changes being made to discount store Five Below FIVE’s strategy could enhance its stock price performance.
A key part of this is the expansion of its estate through the opening of more stores, while also remodelling existing stores. The company is also seeking to become increasingly innovative, while investment in digital marketing could enhance its competitive position. Its increasing focus on efficiency may strengthen its financial prospects, while also improving the customer experience.
With its earnings forecast to grow rapidly over the next couple of years, further outperformance of the S&P 500 could be ahead following the stock’s rise of 72% in the last year.
Store changes
New store openings are having a positive impact on the company’s financial performance. In the most recent quarter it launched 53 new stores, which brought its total number to 745. New stores generated record sales for the quarter, with average unit volumes projected to be over $2 million. The company plans to have over 2,500 stores in operation in the U.S. in the medium term. They are expected to act as a tailwind on sales due to their stronger performance versus existing stores.
Store remodels are being completed as part of an expanded program to enhance the efficiency of the company’s operations. As part of this, Five Below is seeking to innovate, with various tests being conducted in samples of its stores. This includes the "Just Wow" and "Ten Below" concepts that have included extended product lines and differing price points. So far, the customer response has been mostly positive, and the company intends to roll out new concepts across its estate. This could further strengthen its competitive position.
Investment
Investment is being made in digital marketing, with the company’s expanded TV advertising expected to cover around half of its stores in the current year. This compares to 40% coverage last year, and will complement its YouTube and social media campaigns. As part of this, the company has added influencers to its social media campaign. This is expected to improve the visibility of its online offering. It is also investing in its e-commerce operations, which have predominantly served as a pre-shopping tool that helps to drive more traffic to its stores.
An increasingly innovative product line could enhance Five Below’s differentiation versus rivals. Toys continue to be an emerging opportunity for the business, with the void left by Toys ‘R’ Us closures and demand among consumers for a new toy retail destination. It has added a wider range of toys to its inventory, while investing in a variety of other popular categories such as sports, tech and creative opportunities. Further investment in on-trend product lines could provide greater scope for cross-selling in future.
Risks
Tariffs continue to pose a threat to the company’s outlook. Should there be an increase in tariffs, it is prepared to undertake selective price increases. While Five Below believes that this will still mean that it is able to deliver extremely good value for money compared to its competitors, it could have a negative impact on sales growth. With price being a key selling point across its stores, and its customers generally being highly price conscious, there is a risk that it will either need to absorb higher prices through lowering margins, or accept lower sales if they are passed on to consumers.
So far, though, the company has been working closely with its merchants and vendor partners to lower costs without sacrificing quality. There could be scope for this action to be ramped-up should tariffs increase. There is also scope for sourcing from countries other than China over the medium term. Doing so could reduce its reliance on China, which may further de-risk the business as it seeks to aggressively expand its store numbers.
Five Below is also seeking to reduce a variety of costs. For example, a revised point of service (POS) is being implemented. This is expected to improve efficiency, while also providing the opportunity to develop additional features such as a customer loyalty program and greater flexibility for customers to buy online and pick up in store. Plans to construct additional distribution centers may also help to improve efficiency in the long run.
Outlook
Five Below is forecast to grow earnings per share in the 2019 fiscal year by 17%, followed by further growth of 18% in fiscal 2020. This suggests that its strategy is working well, and helps to justify its price-earnings ratio of 52.
With an ambitious expansion program and plans to remodel its store estate, it could deliver further stock price growth. Investment in innovative product lines and in digital marketing may improve its competitive advantage, as well as strengthen its position in what is an increasingly competitive industry.
Although tariffs pose a threat to its outlook, an increasingly efficient business and the potential for sourcing in new markets could mitigate the risk. After outperforming the S&P 500 in the last year, the stock could still offer investment appeal.
