Shares of Five Below (FIVE) jumped upwards on Monday's trading session after the discount retailer reported a solid set of second quarter results.
While long term growth opportunities remain large, the current share price momentum has gone too far, and too quickly to my opinion.
While I can see momentum pushing shares above $50, I remain on the sidelines with a slightly bearish stance, as I think the current valuation leaves more risk to the downside, than potential to the upside.
Second Quarter Results
Five Below generated second quarter revenues of $117.1 million, up 34.9% on the year before, and far ahead of consensus estimates of $112.7 million.
Operating income rose from $4.7 million to $7.2 million, while adjusted operating income rose to $9.7 million.
GAAP net income rose from $1.2 million to $4.1 million. GAAP earnings per share came in at $0.07, while non-GAAP earnings totaled $0.11 per share. Adjusted earnings came in two cents ahead consensus estimates of $0.09 cents.
CEO Thomas Vellios commented on the second quarter performance, "We are extremely pleased with our top and bottom line performance in the second quarter which once again illustrates the strong fundamentals of our business. We saw solid performance across most of our categories reflecting the broad appeal of the Five Below concept, merchandise and value proposition."
Looking Into the Results..
Revenue growth was mainly driven by new store openings, while comparable store sales rose a healthy 6.6% as well. During the second quarter alone, the company already opened 18 new stores, bringing the total count to 276 stores.
While the 6.6% comparable store sales was below the 8.6% reported a year earlier, it was stronger than the first quarter. Growth was largely driven by an increase in transaction numbers.
Gross margins rose by little over 50 basis points to 33.7% of total sales driven by positive leverage in occupancy expenses as the pace of store openings slowed down on a relative basis. These gains were partially undone by the opening of a new distribution center.
At the same time, selling, general and administrative expenses fell by 20 basis points to 27.5% of total revenues. Excluding $1.5 million in transaction expenses related to the secondary offering, expenses would have fallen by 210 basis points. These margin gains are explained by relative fewer store openings as well as operational leverage.
..And The Remainder Of The Year
Third quarter sales are seen between $107 and $109 million, based on 24 new store openings and mid-single digit increases in comparable store sales.
GAAP earnings are seen between one and two cents, while non-GAAP earnings are expected to come in between $0.03 and $0.04 per share. Analysts were looking for non-GAAP earnings of $0.03 per share on revenues of $109.2 million.
Full year sales are seen between $531 and $536 million, based on comparable store sales growth of 5% and 60 new store openings. Full year GAAP earnings are seen between $32.3 and $34.0 million, resulting in earnings per share of $0.60 to $0.63 per share.
Adjusted net income is seen between $0.68 and $0.71 per share, in line with consensus estimates of $0.69 per share. Analysts were looking for a full year revenue guidance of $535.1 million.
At the first quarter results, Five Below guided for adjusted annual earnings of $0.65 to $0.68 on revenues of $524 to $529 million.
Five Below ended its second quarter with $21.1 million in cash and equivalents. The company operates with $19.5 million in total debt for a minuscule net cash position.
For the first six months of 2013, Five Below generated revenues of $212.7 million, up 34.1% on the year before. Net incomes came in at $5.6 million compared to a break-even result last year.
Trading around $48 per share, the market values Five Below at $2.6 billion. This values the company at 4.9 times annual revenues and 80 times expected GAAP earnings.
Five Below does not pay a dividend at the moment.
Some Historical perspective
Shares of Five Below were sold to the general public in July of last year at a price of $17 per share.
Shares rose to highs around $43 in March of this year, and have since then traded in a $35-$40 trading range In the wake of the earnings report shares are currently setting fresh all time highs around $48 per share.
Between the fiscal year of 2009 and 2012, Five Below has more than tripled its annual revenues from $125 million to $419 million. The company has managed to do this in a profitable manner, but reported large GAAP losses last year on the back of preferred dividend payments.
The public offering and consequent price action in Five Below's shares has been a success story. Growth has been fueled by an unprecedented pace in store openings, as well as same store sales growth which accelerated to 6.6% in the second quarter.
While the second quarter results are stronger than anticipated, the full year upwards revised guidance is in line with consensus estimates, indicating this might have been an unusually strong quarter. These comments are made in light of the somewhat soft outlook for the third quarter. Note that the company, although being public for only one year, has already built a reputation for giving conservative guidance.
There are three factors at work here in determining the valuation of the business. For starters there is the growth potential, as Five Below only has 276 stores at the moment, aiming to boost openings by 20% per annum. In the long term the company still sees potential for 2,000 stores. At the same time, margins are decent for a retailer, and while limited operating leverage might occur, I don't expect great margin expansion. Same store sales growth remains solid now in the choppy retail environment.
Back in December of last year I last took a look at Five Below's prospects. I noted that there was plenty of growth potential with room for 2,000 stores, as well as the fact that management appears to be conservative with is guidance. Trading in their mid-thirties I concluded to stay on the sidelines as comparable store sales growth was slowing down, while new store openings are much more capital intensive.
I conclude that attaching a valuation to the business was difficult, being reliant on the pace of revenue growth and level of margin stabilization. Yet I acknowledge the potential of the business, realizing that I might be missing out on a ally in the shares. In the meantime shares have risen some 30% as discount stores remain popular in today's retail environment.
While the company might create a $3-$5 billion revenue business in a decade's time, on which it could earn decent profits of around $250 million, the current valuation has gone too far, too fast.
I remain on the sidelines, with a slightly bearish stance. One or two bearish comparable store sales report could easily spur a large correction.