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Shares of Five Below (FIVE) rose an incredible 18% in Friday's trading session. The retailer focused on merchandise for teens with a value of $5 or below reported a strong set of third quarter results on Thursday after the market close.

Third Quarter Results

Five Below reported third quarter revenues of $86.6 million, up 39.9% on the year before. Sales were driven by new store openings, but comparable sales growth of 8.8% was very solid as well. Revenues far surpassed analyst expectations of $81.4 million.

The company reported an operating income of $1.8 million compared to just $0.7 million last year. Non-GAAP operating income rose from $0.9 million to $3.8 million.

GAAP net income came in at $0.7 million compared to $0.4 million in the third quarter of 2011, with earnings per share coming in at $0.01 per share. Adjusted earnings per share came in at $0.03 per share, beating consensus estimates by two cents.

Five Below opened 17 new stores during the quarter, operating 243 stores in over 18 states.

CEO and co-founder Thomas Vellios commented on the results, "We are pleased to have delivered strong third quarter results. Our top-line performance combined with our disciplined operating model drove adjusted net income to a level more than double that of the year ago period."

Outlook

For the fourth quarter of its fiscal 2012, sales are expected to come in between $167 million and $170 million, assuming a 4% increase in comparable store sales. GAAP net income is expected to come in between $18 and $19 million, with diluted earnings per share coming in between $0.34 and $0.36 per share. Adjusted earnings are expected to come in a penny higher.

Five Below's revenue outlook comes in a touch higher than analyst expectations of $166.1 million. Analysts did expect the company to guide for earnings of $0.39 per share in the so-important holiday quarter.

Full year sales for Five Below are as such expected to come in between $412 and $415 million, assuming a 7% increase in comparable store sales. GAAP income is expected to come in between $19 and $20 million. Adjusted earnings could come in between $26 and $27 million.

Valuation

Five Below ended its third quarter with $7.2 million in cash and equivalents. The company operates with a total debt position of $34.5 million, for a net debt position of $27.3 million.

For the first nine months of its fiscal 2012, Five Below generated revenues of $245.2 million. Net income came in at $0.8 million.

Factoring in Friday's jump, the market values the firm at $2.0 billion. Based on the company's full year outlook, the market values the firm at roughly 4.8 times annual revenues and roughly 100 times GAAP earnings.

Five Below does not pay a dividend at the moment.

Some Historical Perspective

Shares of Five Below have seen a great run after going public in July. Five Below sold its shares for $17 a piece in the offering, and shares ended their first trading day with gains of 56% to close at $26.50 per share. Shares steadily kept on rising, trading as high as $40 in September. Shares fell back to $28 in recent weeks but rallied to $37 on the back of the latest results.

Investors are enthusiastic about the strong underlying growth. Revenue grew from $89.5 million in 2008 to a level around $415 million this year. Earnings growth will be driven by a solid fourth quarter.

Investment Thesis

Investors are applauding Five Below's strong third quarter results. Fourth quarter revenues, guided to come in between $167 and $170 million, represents a 34.0% increase on the back of last year's results. The growth rate is less than the 39.9% reported in the third quarter, but is still very solid.

Growth in fourth quarter is slowing down as the company focuses on execution during the busy holiday season and plans to open only one new store, down from 17 new openings during the third quarter.

Going forward there is plenty growth potential as the company plans to open another 60 stores in 2013. The company sees potential for 2,000 stores in the long term.

Despite the strong results, I was surprised by the magnitude of the jump of Five Below's shares on Friday. The guided 4% increase in same store sales for the final quarter is significantly less than the 8.8% reported in the third quarter. Five below has been conservative in its guidance in its very short lifetime as a public company.

I remain on the sidelines at the moment, thereby accepting that I might miss out on a long term growth story, propelling shares to new highs. With same store sales slowing down, revenue growth has to come from new store openings which is much more capital intensive.

Expectations about the performance of future store openings might be optimistic as well, given the marginal decline of the attractiveness of each new store opening. Attaching a realistic value to Five Below's business is difficult at the moment as it remains to be seen at which level profit margins will eventually stabilize, and how quickly revenues will continue to rise into the future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Five Below: Shares Jump After Strong Quarter, Outlook Conservative

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