Chit Chat Stocks - Five Below (FIVE) | Deep Dive

Episode Date: March 25, 2021

Five Below is a high-growth value retailer for tweens, teens, and others. The company operates over 1,000 locations and offers products in the price range of $1 to $5. Ian, Brett, and Ryan dive into what the company does, what the industry looks like, and how Five Below might perform going forward. As always enjoy the show! Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Follow Ian and check out his work on Twitter: https://twitter.com/IanGrayLive Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to our Youtube Channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Email us: [e-mail] Timestamps Company Background | (2:17) Industry | (6:03) Management & Ownership | (8:25) Valuation | (11:38) Earnings | (12:37) Balance Sheet | (13:42) Our Analysis | (15:42) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Okay, welcome in. This is the Thursday Deep Dive Show. We're talking Five Below today. It is a retailer I think a lot of people know about in the Pacific Northwest where Ryan and I are. We

don't have any stores, so I'm actually going to ask Ian. He's joining us. You got any Five Belows down in the Arizona area? You ever been to one? Yep, so we do have some Five Belows. I went to one the first time um about a year ago i was actually looking for a mask and uh i walked in and i've never been in my sisters had talked about them i was like wow there are a lot of good deals here and so that's kind of how it first popped up on my radar and part of the reason we're talking about it today but they're kind of they've started popping up everywhere in phoenix yeah i mean we'll talk about it they're trying to grow out to basically everywhere in the united states but we're gonna actually wait we're gonna talk five below we gotta do sales pitch uh who wants to do

it ryan you or yeah i think i am probably the best salesman so go ahead uh it's code ccm uh go to seven investing.com they have if you are unfamiliar with seven investing they have seven great recommendations every month uh with good analysis we love the advisors over there um and you can use code CCM to get $10 off. So $7 for your first month, it's, it's a price of coffee, but it's gonna, you know, it's going to afford you many coffees in the future. Maybe two. I think we're thinking about coffee in New York, seven bucks. No, a Starbucks, Starbucks coffee, a fancy coffee. You can get, it'll be seven bucks. Wow. All right. Well, maybe I'm signing with Barbara Corker. Maybe we get to stop.

Maybe that will make you a millionaire someday. Ryan, do you, do you want to get into what five below does yeah so the first line on their investor relations page says five below is a leading high growth value retailer for tweens teens and beyond offering trend right high quality products with extreme one dollar to five dollar value plus some incredible finds that go beyond five dollars so they're a lot like a dollar store um but they're a little more upscale i haven't been in one so maybe ian can attest to that but they sell items across eight categories so it's Style, room, sports, tech, create, I double-typed create, party, candy, and now. Now, what's that?

Like probably just relevant, trendy stuff. Oh, just kind of the other? Yeah, and basically you're getting all this stuff for below $5 or above a dollar, so it's really like cheap value kind of little handy things. And their goal is to make it an entertaining, cheap experience. They try to change out the inventory constantly to keep up with trends. That's why they say trend right. And this hopefully keeps people coming back so they never know what they'll find.

At the end of this year, they had 1,020 locations in 38 states. As we mentioned earlier, there are none really in the Pacific Northwest. You got to pick up the slack there. Come on, five below. And their new store models are about 9,000 square feet. So if you're trying to gauge how big that would be, we've talked about Sprouts Farmer's Market on here before. that's about 26 000 square feet um so it's a little it's about a third of the size of that

um which are sprouts was the perfect example yeah i mean they're small small stores they're not right they're way smaller than a grocery store like walmart is a hundred thousand plus square feet so think about it that way and they're typically centered in like high traffic areas so big shopping centers stuff like that and as for the supply chain five below has about a thousand vendors with 60% of the materials being sourced domestically. No vendor makes up more than 5% of their purchases and there are no long-term vendor agreements. So none of them are exclusive either. And supply chain is a huge deal for a value retailer like this. If they can't acquire the materials for cheap, then obviously economics don't make any sense. But for distribution,

they have four distribution centers scattered across the US. Sometimes the vendors will ship directly to the stores, but usually it goes through the distribution centers. And then I think they also, e-commerce comes from distribution centers straight to the consumer's home. But e-commerce is a very small part of the business and I'll get into the history. So there's not, there wasn't a whole lot of stuff on the early days. The first Five Below store was started in 2002 in the Philadelphia area by a guy named David Schlesinger and Thomas Valois. And And as you might imagine, if you're starting a store called Five Below, you probably have an interesting background. So Schlesinger had recently founded Zany Brainy and Encore Books.

I know some of these names. They have some unique names for sure for stuff they do. Yeah, and Valoy was the CEO at Zany Brainy. So him and the other guy worked together and then they decided to start this five below store in Philadelphia, which the company was originally called Cheap Holdings Incorporated, but the name changed within a year. And then Joel Anderson joined the company in 2014 and he was appointed to CEO within about six months. So I think they knew that he was talented and they introduced online selling in 2016. But, yeah, within 19 years, they've grown store count 1,000x. Oh, you're starting at one.

Yeah. But 1,000 stores in 19 years is pretty fast expansion. Yeah. And I'll hit the industry and landscape. According to the 10K, there's about 63 million people in the U.S. that are ages 5 to 19, which is their core market. They're going after – and I've never been to a store, but the way they describe it, it seems like really the target market is like 5 to 13. and they're trying to get that. So I imagine it's kind of like you're at the mall,

you're going out for shopping with your family as a kid, and you're like, all right, asking your parents, hey, can we stop off for 15 minutes at this Five Below store? That's kind of their value proposition. Management believes they have room to get to 2,500 stores in the U.S., so about 2.5x from here. Other discount retailers would be, and really when looking at it, they kind of have a unique proposition.

So it's not like they're directly competing with all these, but they sort of compete with Dollar General. They sort of compete with Dollar Tree, Big Lots, even like a CVS Pharmacy, Party Stores, too. I think Party Stores is one that probably people don't look at as much because they are kind of that, you know, for the kids' birthday parties, you'd probably go to a five below two. And then Amazon, Walmart, Target, like every retailer imaginable, they're competing with those three. total industry is estimated to be about 94 billion dollars in 2021 and you know fly below is going after a smaller market of that but there's still a lot of room to room to run i guess in the tam although that's not really something people should consider um ian do you have anything on the introduction here before we get into management uh yeah so first just touching

quickly on the competitive landscape one number that they cite is that 46 of their visits to their stores are actually the second visit in a shopping center so someone went to a shopping center for some other reason and then they ended up at five below and so they really are trying to build their model around being in good locations that they can get some of that uh kind of other traffic into their stores and i will say um just having the phoenix uh the phoenix influence here um my experience like you walk into the store and you have your little kind of checkout area at the front and you can see the back of the store from this front of the store. And you can see both of the sides of the stores, right? It's not like some of these shopping centers or these huge things

that are like really big. It seems like a, um, there seems like plenty of space there. It's not a small store, but it's also not overwhelming. You can make your way around it in about 10 minutes or something. So anyways, um, getting into management and ownership, Joel Anderson is the CEO and president. As Ryan mentioned, he was hired in 2015. Before that he was the CEO of walmart.com. so kind of one of those um like the subsidiary of walmart basically and focused on the e-commerce side of it and then before that he worked in multiple kind of executive positions at toys and so has experience in retail discount retail um children's teens tween retail and so kind of a pretty um like a pretty good track record for someone that you're trying to get in a position

like this. And it looks like the transition went really smoothly from the existing team to Mr. Anderson. So one quote that he said that I think is interesting is he said, too many leaders focus on performance first. I believe you have got to start with people. Everything I've done when I've moved to a new company has always been about people. Sometimes it's meant changing people or encouraging current people. But in all cases, to be successful will require starting with the people if you have the right people on the team and then passion for the customer in that order then performance will come so or end quote um so sometimes like we hear a lot of comments like that for management that i think um they're like saying the right thing but it's not actually played out

but in this case i think it has played out most of the management team um is basically from when he started um if not before and so he's kept on a couple of existing people and most of the other members in the management team came around the same time that he did. So there hasn't been a lot of turnover. He's found his team and they've really had some great success over the last couple of years. In terms of ownership, about 6% of the float is shorted. So some short interest, but nothing too insane. It's not like a GameStop situation or anything like that. Insider ownership is about 2%, not large, but not nothing. Mr. Anderson has about half a percent of the company, which is about $50 million. So pretty substantial amount of money for him. He's getting fairly large

equity grants each year, but it looks like he's selling some of those to presumably pay for his lifestyle. But nothing, you know, I'm generally from what I can read and hear about Joel Anderson, He seems like a competent guy who's really executing on the vision so far. Yeah, I like management a lot. It seems like even reading the transcripts, I don't know. It's kind of hard. Like, it's hard to describe, but when you read a transcript or even listen to it, sometimes you're like, all right, they got a fantastic grip on this business. And sometimes you're like, all right, can I just go, nah.

Him, it was like, all right, this is fantastic. yeah and and the other thing about it and you mentioned the transcripts is they give a lot of information both in their 10k and in their conference calls giving whether it's um guidance or they were talking about like how they plan to build some distribution centers this year and how much that's going to cost they try and give people some really kind of clarity into the business as they see it so um that's always nice to see kind of makes you feel better about management too when you feel like they're being up front with you yeah that doesn't seem like they're hiding anything. No. All right. I'll get into the valuation. Ticker is F-I-V-E. So five,

very easy to remember. Market cap right now is about 10.96 billion. So round that up to about $11 billion. Price to sales, 5.6. Price to gross profit of 16.8. So a little expensive there. They're not a high margin business. So don't look at that sales ratio at all and think, whoa, under 10, cheap. We're kind of in that, I don't know, part of the cycle. I don't want anyone to think that price to operating income when looking at the trailing 2020 numbers was 70.8. But remember that 2020 is a down year for a lot of retailers like this. I think their comp sales went down like 6%, but Ryan will probably get into that. So really normalized operating income is likely a lot higher and there's still kind of an investment mode. Share count has stayed

extremely steady over the last five years. So really nothing positive or negative there. They have a small buyback that's not really meaningful and then no dividend. Besides that, I'll just kick it over to the lines of earnings. Yeah. So the earnings were lumpy in 2020 as almost every business has had lumpy earnings, but revenue actually increased 6% to about $2 billion. But that was despite a 5.5% decline in comp store sales. So it was basically just offset by new store openings.

Operating income fell 30% year over year to, I think, I might be blanking on the number, but it was around like $150 million. Yeah, I think $180 million, possibly. Okay. But when we look at Q4, revenue was actually up 25% year over year, driven by 14% comp store sales growth. They increased store count 13% over the last year. And then operating income grew 18% year over year. So strong numbers across the board in the fourth quarter, and they're planning to add another 170 to 180 stores in 2021, but normalize their operating margins probably somewhere around 10%, roughly. I think that's what it was in 2019. I'll try to pull up the numbers here, but Ian, you want to go ahead and hit balance sheet? yep we've got a pretty simple balance sheet here they've got cash of around 410 million dollars

uh no true debt but they do have leases which oftentimes we consider debt um and that's uh they lease out all their stores they don't own any of the properties and they're typically around 10-year leases with options to renew past that so not super long-term leases so um a little bit of flexibility there if a location really isn't working. But their leases total about $1.1 billion in liabilities. Like I said, the balance sheet looks pretty solid to me, pretty simple. One last thing I'll note is that inventory turnover is something that you should keep an eye on and management is actually generally incentivized to increase inventory turnover. It was actually up a bit in the last year. And that was because they reduced inventory by about 10%. And so they had

a little bit more sales, but then also less inventory on the books. And so they kind of ramped down inventory during COVID. I expect that they're trying with these distribution centers, as Ryan mentioned, the supply chain is really important. And so they're trying to find ways to increase the efficiency of their inventory, inventory management. And then they also implemented a new inventory management system. So they're making some efforts to try and keep that inventory number as low as possible. But balance sheet looks good. Should be plenty of capital to fund growth in the future. They're cashflow positive. So not a lot of concerns there. Yeah. And their leases are operating leases, not finance, right? Like you said. So it's not like

that debt there. I mean, there are liabilities that they will have to pay, but it's not the same as long-term debt. Yeah. And I pulled up the financial statement here. Yeah. Operating margin is typically or net margin is typically just below 10 percent on a normalized basis okay this year was a little lower but that's kind of where it usually ranges to okay all right that all makes sense let's take a break and we'll get back for the second half of the show cox panoramic wi-fi includes advanced security to help protect all your connected devices you'll get real-time alerts oh like this one so you don't have to worry about malware or when your kid downloads a song from a shady link and now all your computer can play is red color red color where are you

all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply all right welcome back next up is going to be competitive advantages for five below we'll kick things off with ian what are your thoughts here? The competitive advantage that I'd like to look at today is that they have an established niche. So they target that tween, teen demographic, and they've done a really good job at it. So that helps them to focus their marketing, to focus the store layout, all of those types of things to that audience, rather than being someplace like Target, where they do sell items that are in this price point for this audience, but it's not laid out or set up or all those types of

there's just little things that the company can do that really helps maximize the sales that they have with their core audience. And so I think that established niche also helps them choose different locations, have smaller building sizes, smaller footprints than like something like a target, even something like a party city. So just the between prices, goods, inventory, experience and location it's all catered to capturing that 5 to 19 market yeah yeah the as long as yeah as long as a kid doesn't want to go to costco or target and they want to go to five below i think that's a you know that's it's hard to describe that as like a competitive advantage but it feels like that as long as they keep that up that's that'll ring true and i i haven't been in one

but people say it's entertaining like people say it's kind of fun experience for that age demographic whereas like the dollar store or dollars general isn't necessarily like you're going there to get really cheap stuff in a similar way to five below but it's not like fun yeah uh maybe this is some people yeah ian yeah and i would say like the interesting thing about five below is i it was funny to me when i started researching the stock because when i walked in maybe this just means i'm more of a tween than i realized but i didn't it it seemed like a cool store to me. I was like, oh, wow, look at all these great deals. And I can walk around it in five minutes. And just, you know, I picked up a couple of, I like never shop, but I actually

enjoyed the shopping experience there, which is why I started looking at the stock because I was like, this is so bizarre to me that I actually am somewhat enjoying the experience here. But part of it too, I think is, and this isn't a, you know, I don't want to make a blanket statement, but sometimes you walk into those dollar stores or dollar general or whatever, and it feels like it's not super clean or there's like random items all over the place this felt really well merchandised like there wasn't it was at least the ones that i've been in have been clean they've been organized it's been easy to see where the different sections were you could find everything really fast and it was kind of easy to just roam about the store rather than like sometimes in

those other dollar stores it's not like you said it's not really a fun experience it's a little bit maybe a little bit messy a little bit cluttered um so anyways just my two cents it honestly like i was going through the industry it seems like you know you can say like all right there's all these competitors in retail there really seems like there's not any competitor i mean i can put on my galaxy brain hat and say that maybe roblox is their competitor i know that's the hot name that everyone talks about now but it's really like the place where people you know or kids are going to interact and uh buy things for themselves and you know gifts for each other It's funny that you mentioned that because that's going to cater well into my future

growth opportunity. Okay. Ian, you got anything else? Yeah, I've got one last thing. I think when you're looking at Five Below, and I think there's other businesses like this as well, that this is kind of a helpful framework, at least for me to analyze some of these businesses. So I think sometimes about who are the business model competitors and who are their target

market competitors. And so in this sense, we'd say like the business model competitors would be things like Dollar Tree, Dollar General, kind of those competitors that are really trying to find bargain. And you can match their type of business model to build your own models about what you think Five Below will look like in the future. But when you're talking about capturing a market, they're not really competing against Dollar Tree or Dollar General for the most part and trying to get that same audience. It's actually two different audiences, but they have similar business models in these two audiences. So, um, that's kind of how I think about this business. I think

there's other businesses because like, it's kind of a joke, but like you said, like even Roblox could be a little bit considered, um, like a, a target market. Um, spending money, they're spending kids are spending money. Yeah. So I'm going to dive into my competitive advantage and that is basically against sort of the digital retailers, e-commerce for tiny, tiny goods, like stuff with less than five dollars especially if you're buying it like just a singular item uh the shipping and logistics it doesn't really make practical sense uh the economics of shipping one tiny item um because there's so much cost that go into the back end of that so i mean amazon can afford to lose money doing that but even amazon but even amazon tries to they i think they try

to sell kind of this stuff in bulk because it just really doesn't make sense. I mean, if you're pairing it with something else, Amazon has that infrastructure to ship that kind of stuff well, but like one tiny item, like shipping one mask probably doesn't make a whole lot of sense. And so this is something that feels like it won't be digitized that much. This shopping experience of little one to $5 items, I think will always be done physically in person. um so i guess there's that niche um or that advantage uh that this is just something that's sort of immune to digital changes yeah and with the e-commerce uh okay amazon is really more of a utility for like adults like us yeah and five below like they they probably haven't

been on the website or actually no i checked it out for a little bit it's really catered for you know a kid's experience where they could like check it out and it's like probably a great way to i don't know send a gift to your cousin in texas and even the like their e-commerce i didn't look at the numbers and you said it's a pretty small portion of overall sales right yeah they don't report exactly what it is but they say it's not material at this point okay okay and if they're saying it's not material after a pandemic like this feels like something that's yeah probably not going to go digital yeah yeah for sure all right what do you have um i think this one's easy there's classic economies of scale so they're going to get to 2500 locations or you know they're

guiding for 2500 locations they're going to end up having better negotiation negotiating power with suppliers either you know to get that accounts payable a little later or whatever that would help with cash flow um they're going to be able to use that uh to get lower prices for their customers, and then they'll be able to stay profitable at the same time. That gives them an advantage over the mom and pop shop. It's no different than any other retailer. In that instance, you could probably compare it to Walmart or Costco in that sense. But that model works so well because the advantage and the moat they can build is just really strong. I mean, I guess, again, Dollar General has that as well. I don't know much about Dollar General, but from what I've

red it seems like they've been able to you know just keep prices low through their economies of scale and the ability to get a store up and running rather cheap yeah the supply chain seems like an advantage i mean maybe it's not a competitive advantage but the fact that they're able to acquire all their materials so cheap allows them to the i mean that is their entire customer value proposition is the cheap experience that these customers get yeah yeah yeah and then two other quick things on that you know i think you also get they like have some branding agreements both they were doing some like stuff with fortnite and some fortnite gamers i think to do like special uh like plush dolls of like you know your favorite fortnite star or whatever so they they

kind of are able because they're so big they're able to cut some of those deals with places like fortnite places like disney um and then the other thing that i've just started realizing a little bit more of the five below once you have a big established um uh like a store footprint like they do or a store uh network like they do they've got over a thousand stores they get to do a little bit of the ab testing kind of like we talk about facebook doing a lot with as many users as facebook has they can do all sorts of testing and all these different locate or and all their apps to all of us to you know see what works the best five below can do the same thing in all these different locations and try out new um you know new floor layouts which they do from time to time they can

try out uh like they've started selling um some other goods that are a little bit more than five dollars in some locations and seeing how that works and so it gives them the ability that like a startup wouldn't necessarily have to test things out and see how it works yeah that does make sense uh yeah i'll agree ian do you want to hit up uh what is next future growth opportunities Yep. So Ryan's been mentioning e-commerce as that it doesn't make a whole lot of sense for Five Below. And I think I agree. However, they do mention it from time to time and they say, you know, the CEO is the former CEO of Walmart.com, presumably has some affinity for e-commerce. he said quote our e-commerce business continues to grow at a pace significantly faster than our stores however due to the small base the overwhelming majority of our sales still come from our stores close quote so i'm not sure exactly what i think of this i don't know

i don't know how much growth is there i agree with a lot of the points you're making ryan that i don't think that this is probably geared towards e-commerce but i do start thinking about some of that especially as they grow out more and more stores some of that omni-channel kind of method where you might be able, you know, they could even put out lockers outside their stores and say, hey, build this, you know, make an order and then come pick it up at our store just to get a little bit of some incremental sales. But what were you going to say, Ryan? Yeah. And I think they just signed a partnership with Instacart as well. But I think that that fortnight sort of angle when you take it from your maybe just becoming the

logistics infrastructure for vendors could present some good stuff in terms of e-commerce so if you're buying a plush doll or whatever of a fortnight character after i mean they just signed this goes into my future growth opportunity but they just signed some deal with gouda or buddha or uh he's like a popular he won the fortnight world cup in 2019 wow so he's like this big sort of character in esports um so if you're doing stuff that way and you can kind of just maybe people don't know it as a five below item but they're powering that back end that that could be a big sort of tailwind for the e-commerce side and then my growth opportunity was esports so they made an investment in a company called nerd street gamers which is uh it's a philadelphia esports network so

they host events tournaments that kind of thing um and in the fourth quarter five below opened three local host test centers so and they're basically just they're adjacent to a five below store so go right next to it and then local host is a training center for gamers which it seems like a strange narrative to go that way but becoming synonymous with gaming might help on the e-commerce angle yeah it's there's a lot of factors going into the e-commerce market for them because they have to weigh the fact that a lot of their items, you know, five below, it's going to be really cheap. But it seems like there's some opportunities there,

but it's not going to be as streamlined of a process as like, all right, we're just going to keep opening stores, keep this model going. There's a lot of variables at play. What do you guys think about the esports angle? Because it seems random. No, I think it's smart because it's huge for that age group. And the fact that you can come into,

I don't know what these partnerships are. I honestly didn't look, but any sort of esports partnership, I know that my younger cousins love watching Twitch. So I think that market, the market overlap seems strong. Ian, what do you think? Yeah, I think just exactly what you're saying. They talk about being, quote, trend right and really trying to just be with the times. And that's so important for that tween, teen demographics is that you're with the times.

You don't want to be last year's stuff. You don't want to be, you know, you don't want to be boring anymore. You don't want to be out of style. So I think for now, they're making those investments in esports. And will it last? Who knows? It depends on how big esports will continue. But I trust the management team to continue to invest in things when it looks profitable and pivot when it starts going out of style. yeah this is the interesting part about their business is they're gonna have people graduate from their target demographic but they hopefully are going to have new people entering each year uh but the only downside with that is that yeah you have to adapt at times um i'll hit my future growth opportunity i'll i'm stealing the easy one plenty of room for store growth they have

what a thousand right now they're opening over 100 each year and if they can get to 2500 stores and keep up some solid comp store growth. I mean, there seems like an easy, not easy path, but you can see, you know, $8 billion in sales. I mean, that's a lot higher than now, but, you know, some buy-in by 2030. The model is so predictable that if, unless there's a huge change in either the culture

or I don't know, if someone comes up with some innovative thing in e-commerce, there's a hard reason to think why they wouldn't be able to get 2,500 stores out there. And at that point, maybe they could get their margins up to, I don't know, 12% instead of 10% now. I know that doesn't seem like much, but at that point, you could be pushing close to a billion dollars in income. I don't know. That's pretty speculative.

That's a lot far out, but there seems to be a clear path to store growth. Yeah, and $2,500, it doesn't have to stop there. If they see expansion, it could go beyond $2,500. that's just what their their minimum goal or target is yeah it's kind of their target yeah what would that be it's probably by sometime like 2030 maybe at this pace probably before that for that with they're going what 180 stores this year yeah that's it seven or eight years yeah yeah all right um highlights and low lights and you want to go first yeah mine kind of go right right in line with what uh brett was saying a simple model you know currently with just about

a thousand stores growing to 2,500. There's just, you see the path, right? It's easy to see where this thing is going as long as things stay on track. And then on the margin point too, they've talked a little bit recently that this is going to cause, like adding all these stores is going to densify the model, meaning that there's going to be more stores in each city. There's going to be more stores in each state, which creates a little bit of cannibalization. They're seeing about one percent of sales when they build a new store sales at surrounding stores drop by about one percent but the additional sales more than make up for that and the additional brand recognition more than make up for that and so the other piece of densification though that they like

is that it increases the margins at these stores because people are they're spending less on marketing they're spending less on like on distribution because they've got more stores that are close to each other. And so their supply chain becomes more efficient. And so it just it seems like this is going in the right direction. And the model is going to get more efficient as it gets more mature. So it's kind of it's kind of that double whammy there that's that I like to see. I will say, as far as low lights, it's it's a little bit hard for me to see some low lights, but one of them would be inconsistent, inconsistent comp sales growth. They have been growing comp sales every year until this year, but, um, it's not super linear. Uh, some

of it, sometimes, uh, the comp sales go up because the average ticket was up. Sometimes it's the amount of transactions. Sometimes one of those two factors actually goes down. So they don't seem to have a clear strategy about driving more tickets or the size of the ticket. So, uh, that's, that's, that's the one low light I will point out. Yeah. To be honest, I was having trouble finding lowlights too. I think the business sounds, I don't want to say bulletproof, but pretty darn sound. Ryan, what do you think? Yeah. My highlight is the strong economics of the business model of profitable after a year or whatever. That's the payback period, which when you're profitable that quick, it allows you to expand a little bit faster because you can

generate, you can do it organically with the cashflow that you have and not require outside debt um but low light for me uh the share repurchase felt really random and unwarranted it was tiny but it was like 100 million dollars over the next four years which just felt like wasted cat i mean they're not cheap they're not like a screaming yeah it's getting cat bags going yeah just like why not just speed up store count i guess with that 100 million i don't think they actually bought anything yet so maybe it's just out there in case their price points it felt like a shareholder tease like we could if we wanted to you know with a model like this it honestly feels like once they get to scale the ideal situation is someone like autozone where they

destroy 80 of their shares over you know once they hit kind of the saturation you know like autozone really didn't have or i think it's autozone right i think yeah i think whatever company it is and there's other examples where they kind of hit market saturation which five below it's going to do eventually with their current model if the the valuation stays like low right now it's a bit high right if it stays fairly low you just buy back a ton of your shares but that that seems way into that's my worry is that there it feels like there's a ceiling it it feels like all right let's say 2500 is that threshold of store count you could see them easily get in there that's great you know some of that might be priced in but then what do you do

raise prices like your store is built on not raising prices that's the whole narrative i guess ian do you have a point to that yeah just the only point is then you start thinking about an international you know that's the that's always what you know management teams say and it's a little bit cliche but i think for five below um once they started to tap out and get got close to tapping out in in the u.s they'd say hey let's go let's go check out the international thing so yeah and there's some countries that this type of like well in general some countries seem to hate chain stores but there's plenty out there that that kind of you know like chains and i would think this model would work anywhere um yeah i don't know i wouldn't i mean i wouldn't

know the other demographics as well but i guess you gotta really cater to the you know each culture is different so yeah what are what about you highlight um i mean the predictability is probably my favorite part. It's so simple, but it's like, again, like I said, it's almost bulletproof. Stores are profitable. Within a year, I think that was one of our, each of us had that. And that gives them the opportunity to spend about 200 million on CapEx each year while staying free cashflow positive. That is a great advantage. And I do love the defensibility versus Amazon or Walmart. There's not really, Amazon can't invest $5 billion and crush them. It's really not going to happen low lights though again the market saturation thing uh i the comp sales

again we're a bit of a worry but those are a bit of a stretch does i don't know if this one is real but does inflation hurt them at all ian you seem to know the business a bit more you have any thoughts on that is that no it's just a name change six below six below seven below i know they have the five beyonds but they're they can't make that the entire store yeah i suspect what we'll start to see over the next few years is um i you know they do seem to be pretty creative with their names so they may come up with a new name and and uh be able to up their prices a little bit but i do expect that maybe it'll be a slow transition but we might start seeing more and more five beyond goods and less and less five below goods um and that they may even be looking

at that as the the the name of the future but we'll see i don't know i think i think it's a little bit of a concern because they have built their brand so much around five below quality um quality inexpensive goods but uh i i assume that they'll fit that they've got some sort of plan for that five below in parentheses inflation adjusted inflation yeah yeah exactly exactly all right uh i think that's gonna do it no more or less interested uh well first of all it's the one year anniversary of the market bottom today so yeah i was looking at their one year returns and i was like wow 100 i was like oh it was like 60 a year ago i think right now it's at 192 yeah every every one year chart looks incredible right now yeah uh but one go ahead sorry ryan

more or less interested in yeah this is one that i i took a look at back last summer and it's one i'm kicking myself a little bit for not getting any of because like he said the one year chart looks praising but um i'd say i every time i look at this business i get a little bit more interested just because of how good simple predictable it seems and um you know you can never like it's hard to discount that right to say what just a good solid company right and that's that's at a fairly reasonable valuation comparatively right we could argue about valuation all day long but compared to a lot of the things in this market this does not have a crazy multiple on it right now so um i'd say i'm i'm slightly more interested all right ryan yeah

normal i mean it's i'm less interested i know this is uh kind of a wow haters i know i don't know it doesn't get me super excited and this feels like i mean normalized it's trading on operating income multiple, probably like 50, 40 million. I know that's cheaper than comps, but I guess this is the kind of business that I'd like to own if it were screaming my name. Right now, it just doesn't excite me. And something just feels daunting about the fact that they've kind of capped themselves out. Whether it's the 2,500 stores, the $5 price limit, I know that isn't really a threshold but it feels like they're going to have to sort of contrast against their narrative in order to raise prices or do more five dollar plus stuff or they're going to have

to expand internationally but i don't know it just feels like i always hate investing with a cap like a theoretical cap yeah and a good management team might surprise you but yeah that is definitely concern here i mean the esports i guess provide some optionality but it feels like if you're talking about optionality with this business it's kind of you're reaching just trying to justify the the current valuation yeah i mean valuations the concern for me as well um but i do think the business is i mean it's sound bulletproof i've said it like three times it's it's just so simple so predictable but it's just got it's not i'm more interested but the business is something that i feel like it's going to be on my watch list forever um at 40 times normalized earnings

so yeah would i be surprised if it outperforms the market no but i mean i don't know let me pose this question what multiple do you think this would trade at at maturity i'm sure i don't know 25? 25. It would definitely get a decently premium multiple. A little bit above. A little bit above market average. If I'm saying a long-term market average is like 20, I'd say this probably deserves like 25. So that's, I guess my concern is let's say it's 25 times or even 30 times. And right now we're all saying it's a very predictable business. That's why it trades at 40 times, no? Yeah. Yeah. No, that's true.

I mean, I guess right now it trades at like 70 times trailing, but the trailing numbers are off because of COVID, I guess that predictability, it feels like maybe that's what the market's pricing in. I think it's the type of thing that if you're looking at this a year ago, it's much more, and I was, and I didn't see it at the time, but it's a much more attractive thing. And I think this is, at least for me, this is that type of stock that I try and keep on my watch list. And if something like COVID happens again, where it just has this huge drop and you think okay maybe maybe time to pull the trigger on this one because it's it's uh you're going to get some outsized returns over the next few years but like you were saying brett i would

expect you know this thing it wouldn't surprise me if this thing was a 10 to 15 compounder for the next five to ten years but it's probably not going to be the thing that's going to it's not these micro cat picks that are going up 100 in three months right it's not that type of return or even 100 in two years it would surprise me if it doubled again from here in the next two years Yeah. I think the biggest thing that would concern investors is just boredom with this business. I think you would just get bored. And I guess most people I think do. I mean, Ian brings up a good point there. Like maybe you're paying a little bit of a premium now, but the forecasting of the business or of the fundamentals from here is pretty easy.

10% margins at least. So it makes buying on downturns a lot easier as well. Yes, for sure. all right we're gonna wrap things up yeah what stock do you have for next week yeah i think you guys are gonna like this one it's gonna play off of the fashion thing i did three weeks ago we're gonna do far finch uh okay i don't know what the business is at all but a lot of people seem to like it they're throwing out 80 revenue growth and i'm like all right cool let's just take it out yeah gotta love top line growth yeah and everybody knows we're the fashion experts so

So, you know, that's the most fashionable people on FinTwit, right? That's what people call us, right? That's exactly right. Value investors are known for their fashion. Buffett is basically... No, I don't know. But that's going to do it. Thank you all for listening.

Thank you, Ian, for joining us. Remember, we are not financial advisors, so anything on the show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital and clients in Arch Capital. May hold securities discussed on this podcast. Am I missing anything? Thank you all for listening.

We'll see you next time. Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad. I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today, I'm still figuring it out. Somehow, things usually get worse before they get better.

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