Cabot’s “Next Amazon” Pitch

By Travis Johnson, Stock Gumshoe, August 15, 2018

This teaser solution originally appeared as part of a Friday File for the Irregulars on December 15. The ads are still running, this time under headlines like “Time to Bet the Farm”, so we’re taking another look, including my updated thoughts following the last quarterly report (I own this one), but most of the teaser solution commentary — and the ad — is unchanged from 12/15/17.

The teaser comes from Mike Cintolo’s Cabot Growth Investor, which is just what it sounds like: a newsletter that picks growth stocks. Cabot’s strategy tends to focus on momentum stocks and rapid growth in most of their newsletters, so the stocks they teaser are often expensive-looking, and this one is touted as “The Next Amazon.”

These are the clues we get:

“It’s already growing its earnings 81 times faster than Amazon and has outperformed it by 25% over the past two years.

“Here’s why it could jump 50% on earnings and double soon after that….

“That’s because the company’s low price point products appeal to the fastest growing demographic on the planet: millennials.

“You see …

“Unlike Amazon, which sells everything under the sun, this company has carefully targeted its market to teens, pre-teens and their parents—selling them must-have, in demand, fashionable items along with seasonal must-haves for Easter, Halloween, Christmas and more.

“But time is running out on getting in on the ground floor here.

“As we head into the holidays, orders are starting to pour in from all over the world. The company’s cash register is starting to work overtime.”

So… hoodat? We’re keeping it short and simple on the teaser solution front today, so I’ll just tell you that this must be: Five Below (FIVE)

Which has been trying to essentially ride the dollar store craze while also adding the old “fast fashion” secret sauce from the Target of the 1990s — the stores feature things that cost less than $5, and they focus on seasonal goodies and, well, fad and fashion-driven semi-disposable junk. Like fidget spinners and ugly Christmas sweaters.

And it’s been working — they’re growing fast, they’re expanding the store count rapidly, and analysts see pretty dramatic earnings growth in the 20% neighborhood for as far as the eye can see… the only problem, really, is that they’re expensive. That’s not uncommon for fashionable retailers who are rapidly building out stores and showing dramatic top-line growth, such stocks often get expensive (remember Chipotle?) … and it works as long as it works, as long as those stores can keep getting added without hurting the same store sales growth.

The big benefit for FIVE over the also-somewhat-fashion-driven and successful (but much larger) dollar stores like Dollar Tree or Dollar General is that they have a tiny store count — only about 600 stores now, probably adding 100 or more this coming year, that kind of buildout can create really stupendous top-line growth and cure a lot of ills when it comes to per-store performance… so when per-store performance is also really good, like it was last quarter for FIVE, the leverage for the stock price can be pretty dramatic. In a world that hates retail stocks still, despite the recent recovery of the sector, FIVE is appealing because of that growth: Store count growth, same store sales growth, and huge top-line revenue growth.

It’s still tough to buy a stock like FIVE, because it has run so fast and is trading at a forward PE of about 32, but that growth rate makes it much more reasonable if you can stomach the fashion-driven hits and misses — I don’t know if I’d jump on the stock at all-time highs, but I wouldn’t argue against nibbling a little bit and hoping there’s a little letdown after the Christmas shopping. They don’t report earnings again until March, so things could quiet down for a bit if the market ever takes a little vacation from bullishness.

And to update thing since I wrote the above…

Yes, I did end up buying a position in FIVE, both calls and equity, because of that combination of strong underlying growth and the expected large impact of the tax cuts on their income for 2018. It could be that the tax change alone might increase FIVE’s net income by as much as 20% over what it would otherwise have been. That, I theorized when I bought the shares, could bring the forward PE down from 32 to 27 or so.

And then, last quarter out, Five Below blew out the analyst expectations and raised their forecasts, and the stock surged over $100 and hasn’t looked back. Here’s what I wrote to the Irregulars at the time, back in June:

FIVE is generally lumped into the “dollar store” category, it’s the teen-focused retailer that sells most everything for under $5 and is heavily fad and fashion driven, with a jump in earnings last year from the fidget spinner craze and, more importantly to my investment thesis, a very small footprint that they’re aggressively expanding across the country. I bought shares starting back in December because of the two levers that I thought would be operating on their earnings growth: Taxes and Store growth. They are a major beneficiary of the corporate tax cut, since they’re entirely a US company and they paid a pretty high tax rate before January, and they are small enough, with only about 700 stores now, to grow dramatically in size before they run out of appealing new markets to enter.

To give you some idea of the impact of rapid store growth on the top line, they had “comparable store sales” growth last quarter of about 3.2% (which was in the guidance range, though the number of transactions was down a bit because of the cold spring weather), but because they can open stores quite efficiently and get them up to speed fast, and because the store count is so small that they’re actually increasing the total store count by close to 5% each quarter, the actual total sales increased by 27%. On top of that, the lower tax rate helped them double earnings in the quarter, year over year.

Of course, none of that was a huge surprise to analysts — they were expecting big growth, and the company had already guided to strong growth… it’s just that they did about 5-10% better than expected, depending on which metrics you use, and, as importantly, they raised their full-year forecasts. No matter what market you’re in, a “beat and raise” quarter is going to get investors excited, and in this market of growth enthusiasm it’s perhaps stronger than usual… so the stock opened almost 20% higher on Thursday morning.

So even with using ‘weather’ as an reason for their traffic and transaction volume being down a bit, which can be a red flag, they beat the expectations handily. In case you’re wondering about which products are driving the bus right now, there’s not one specific one (like last year’s fidget spinners), but, according to management on the conference call, “slime, smiley, squishy, spa and mermaid trends continued to be popular.”

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The financials point to the risk of a letdown in their second quarter, which ends July, mostly because the comparable year-ago quarter was the major beneficiary of the fidget spinner craze so the comps are challenging, so it might be that we’ll see the shares come back off of these highs a bit — but the company is doing everything right and I remain very impressed with their growth strategy and their ability to bring new stores into the fold so quickly and remain so nimble with fads and fashions.

Next quarter’s results will probably depend on whether or not their summer-themed sales take off, with giant beach umbrellas and emoji towels and whatever else, so it’s possible that we’ll see some dips, but I think this one is worth holding even at these much-higher prices — a regional store going national can be a phenomenal investment if they can open new stores with relatively small capital investments and make them profitable quickly, and FIVE is getting it right.

You can see the conference call transcript here to get an idea of what management is focused on. This is certainly not a cheap stock — with expected earnings of about $2.45 (that’s the middle of the company’s forecasted range), it trades at about 40X current-year earnings — so it’s not one that I’d want to be the largest position in my portfolio, but the growth potential is very strong and they’re building at a speed that would have them almost doubling the store count in the next five years, and that would still have them well below their potential market of 2,500 stores. So in some ways this stock price surge is just a validation that Wall Street believes them now.

That won’t necessarily stick, you never know — but if they can get through another good year of merchandising, it could be a fantastic year for the company… they are guiding to just 1-2% comparable store sales growth and almost 20% sales growth overall, with impressive discipline in keeping costs under control as they expand, but they’re still fashion-driven and hit-driven. That means if they have another “fidget spinner” quarter this year they’ll blow out those numbers and the stock could soar, if they have a flop in the fourth quarter and don’t have good holiday sales, the stock could get cut almost in half (about half of their earnings come in the fourth quarter, like most retailers).

So… fingers crossed. I expect to see the 2020 earnings estimates (that’s their next fiscal year, ending in January of 2020) rise into the fall, probably by about 10%, and that will mean the stock at $99 would be trading at roughly 30X forward earnings. That’s reasonable for this kind of growth, but the stock is also volatile around earnings and general sentiment about retail stocks (which has become strong again recently) so it’s quite likely that we’ll see the shares dip to more appealing prices along the way, too. If I didn’t own, I’d think about a first nibble in the low $90s if it dribbles back down to that point. It hasn’t yet gotten below $97 or so following the last earnings report, but the market is certainly volatile these days so it’s hard to guess what the next two weeks will be like — they should report their next quarter around August 30.

Over to you, friends — it’s scary to ride a teen-driven fashion story like FIVE, but the store count and same-store-sales growth numbers convinced me. Is it enough to catch your fancy, or is the hefty valuation too much for you? Think they’ll see analyst upgrades in this lower-tax regime, or do you think it’s already baked in? Let us know with a comment below.

Disclosure: I sold those call options a while back, but still hold shares of Five Below, and I also own shares of Amazon. I will not trade in the stock for at least three days per Stock Gumshoe’s trading rules.

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January 10, 2018 7:52 pm

Hi Travis, I’m still having trouble logging in. I cleared my cookies, etc as you suggested but it didn’t work. Any further suggestions?

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January 11, 2018 9:19 am

I am having a similar problem logging in. I hti the login tab and the screen flashes and i am still not logged in to see the Irregulars Quick Take. Some times I click on another link and it links in but the Login button has not worked for several weeks.

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January 12, 2018 11:50 am
Reply to  rocket_man

Work around for me was to click on ‘signup’ and I was logged in.

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January 12, 2018 12:08 am

Thank you for addressing this.I have been having the same issue. Can’t even find a log in info box. Had been working seamlessly by just the login box on an lg V20.

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