Five Below has a monster opportunity

With revenues and net income growing at a compound annual rate of 25% and 33%, respectively, over the past decade, the discount chain five below (FIVE -1.19%) had no problem registering massive growth. And the stock has followed suit, rising almost 400% since June 2012.

This boom retailer, which had 1,190 stores in 40 states as of Jan. 29, has a big opportunity to boost its e-commerce capabilities. Management emphasized this pillar of growth in a recent Investor Day presentation, giving investors a lot of hope for the future.

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Five Below can generate additional sales

Not all physical retail is dead, and Five Below proves it. The company has rapidly expanded its store footprint over the past 10 years, which makes perfect sense given each location’s lucrative economy. The average Five Below store requires an initial investment of $400,000, but generates $2.2 million in revenue and $550,000 in four walls. earnings before interest, taxes, depreciation and amortization in the first year of operation. Opening stores as quickly as possible was the right decision.

Despite plans to triple the number of stores to 3,500 by 2030, management is focused on leaning heavily on digital to increase accessibility and convenience for shoppers. Five Below already has a mobile app, but in fiscal 2021, e-commerce sales were less than 7% of overall business, meaning there’s a huge opportunity.

“Last year, we brought even more convenience to our customers by enabling same-day delivery in all of our markets,” said Felipe Zardo, senior vice president of digital, on the Call for fourth quarter 2021 results. “And later this year,” he continued, “we’ll be rolling out ship from store to select locations and buy online and pick up in store across the chain.”

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

The benefit of having a larger e-commerce business is that it allows Five Below to interact more with its most loyal buyers, which helps build brand strength and increase repeat purchases. At the same time, the company can collect massive amounts of data that can inform product and marketing initiatives.

From a financial perspective, online sales generally generate 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 bigger part of the business, as management hopes, margins should increase. These additional sales should increase 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 enhancing e-commerce capabilities can be a boon for Five Below, it is not without its risks. The most obvious, in my opinion, is that this move will put Five Below directly in competition with Amazonwhich could be a losing proposition.

Five Below prides itself on providing an enhanced shopping experience, as its stores utilize colorful, dynamic layouts and a scavenger hunt environment that encourages aisle browsing. Therefore, going to a physical location is part of the company’s value proposition. And because the items are so inexpensive, mostly under $5, impulse purchases in stores can be a big source of income. How management balances the in-store experience that has propelled the business thus far with the online push over the next decade will be key for shareholders.

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

Even without a huge online presence, Five Below has proven its investment merits, which are more impressive considering the struggle of many other brick-and-mortar retailers over the past decade. This is a quality company that has carved out a place for itself in a highly competitive industry, and I believe the success will continue.

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