Far from Cheap, Discount Retailer Five Below Is Still Undervalued

NEW YORK (TheStreet) -- It has been a bloodbath for several retailers this earnings season, which has sent the SPDR S&P Retail ETF (XRT) down 1% over the past three months.

Even some of the more prominent names such as Lowe's (LOW) have gotten crushed. And it isn't hard to see why, given disappointing data on April retail sales.

But it is tough to ignore the value of discount retailer Five Below (FIVE), whose shares are down 17% for the year to date, for reasons that don't make any sense. It is even more remarkable to see the stock punished almost 30% just in the past six months, while the SPDR S&P Retail ETF has advanced almost 4%.

Take a look at the chart:

FIVE Chart
Ahead of the company's fiscal first-quarter earnings results due out Wednesday after the close, this is a name investors should watch. The stock's decline doesn't jibe with the company's performance because all the Philadelphia-based company has done is execute, posting revenue and earnings beats for six consecutive quarters.

The company has had consistent beats in same-store sales, which were up 3.2% in the recent quarter. For some context, same-store sales at better-known retailers such as Target (TGT) and Wal-Mart Stores (WMT) rose just 2.3% and 0.4%, respectively, in their recent quarters.

This points up that Five Below isn't just a fast revenue producer. The young company, which was founded in 2002, is holding its own in the metrics that matter to analysts and value investors.

Granted, the stock isn't cheap at 37 times earnings, which is 16 points higher than the average stock in the S&P 500. But still, at that premium multiple, investors are paying for growth, and growth is what Five Below has delivered.

Consider that in the past 10 quarters, the company's revenue has grown by an average of 26% year over year. In the past four quarters, revenue has climbed by an average of 28%, showing an acceleration of 2 percentage points.

For this reason and others, Five Below has a consensus analyst buy rating and an average price target of $40, implying 20% gains from current levels of about $33. So though the shares aren't cheap, that doesn't mean lack of value.

And on Wednesday, the company will likely outline how it plans to extract that value.

For the quarter that ended in April, average analyst earnings estimates call for 7 cents a share on revenue of $151.4 million, marking flat growth and 20%, respectively.

Five Below is projected to increase earnings at an annual rate of 29% over the next five years, including a 27% earnings increase for fiscal 2016. This implies an earnings acceleration rate of 6 percentage points next year, which should lower the price-to-earnings ratio.

In that vein, buying Five Below stock today makes tons of sense, especially before the market wakes up to how undervalued these shares really are.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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