Five Below: Looking For An Entry

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About: Five Below (FIVE)
by: Leo Nelissen
Summary

Five Below beat both earnings and sales estimates and raised its full year guidance.

Margins continue to be strong as both comps and new store growth remain at impressive levels.

Even though consumer sentiment is peaking, I have no doubt that Five Below is a great long-term investment.

Five Below (FIVE) just released its third-quarter earnings. The company beat both its own and Wall Street expectations and raised its full-year guidance one again. Margins were roughly unchanged while the company added a record number of new stores. All things considered, I believe we are dealing with an interesting long-term opportunity that should be bought during corrections.

Source: Five Below

3 Words: Better Than Expected

Five Below did it again. The company beat both its own expectations and official Wall Street expectations. Adjusted EPS came in at $0.22 versus expectations of $0.19. This is 22% higher compared to the prior-year quarter. Note that unadjusted GAAP EPS is $0.02 higher due to employee share-based compensation. Total net income reached $13.5 million compared to $9.9 million in Q3/2017. This translates to a 36.8% increase. Note that the company expected to generate net income between $9.7 - $10.7 million which is a very impressive beat.

Source: Estimize

Five Below's sales totaled $312.8 million versus $275.2 million in the previous-year quarter and analyst expectations of $303.0 million. The company's own expectations range was $301.0 - $304.0 million. The year-on-year sales growth rate is currently 21.6%. There is no notable sales growth trend which is good news since most established retailers have shown slowing sales trends.

One of the reasons why sales growth is higher than 20% is the company's expansion. 53 new stores were opened during the third quarter. This is a new record and translates to a growth number of 19.2% of total stores. The current store count is at 745 spread over 33 states.

Comparable store sales came in at 4.8% which is very impressive number considered that most peers are much lower. The company's strategy is completely paying off. Not only is the lower income customer are an interesting market to operate in, we also see that Five Below continues to have great success when it comes to marketing and the overall choice of products.

With our increasing scale, digital marketing expansion and store densification strategy, our brand awareness is growing and we are seeing great opportunities for product, real estate and talent. We believe we are well positioned to continue to execute in the second half and look forward to continuing to provide our customers with the amazing, one-of-a kind shopping experience that is unique to Five Below.

- Joel Anderson (President & CEO)

Another thing that is quite uncommon is the strong trend of rising margins. There are no signs of weakness as the company continues to improve its bottom line.

Gross margins are currently slightly above 36% on a trailing twelve months basis. This is more or less unchanged compared to the end of 2017. The same goes for EBITDA margins. Nonetheless, both were able to grow without any major disruptions despite rising inflation since 2016 and the fact that the company is operating in a low-price segment.

So far, we got a few important facts.

  • The strong sales & store expansion continues and is even accelerating
  • Comparable store sales are rock solid and erase worries that the sales growth trend is solely based on addition stores
  • Margins continue to be solid in a challenging environment

All of these points are important. However, one thing is missing.

What's Next?

Good results are worth nothing when the outlook is bad. In the case of this Philadelphia based company, I am happy to report that management raised guidance across the board. Full year net sale are expected to be in the range of $1.550 to $1.557 billion versus the previous range of $1.528 to $1.540 billion. Comparable store sales growth expectations have been raised to 3.3% to 3.7% from 2.50% - 3.0%. Net income expectations have been raised roughly $5.0 million to $146.9 - $148.9 million.

In other words, add the next bullet point to the ones above:

  • Company raised guidance once again

There is just one problem. I have discussed this problem in every single article covering retail stocks. Consumer sentiment is rolling over after being in a 10-year expansion since 2008. University of Michigan consumer sentiment is peaking at multi-year highs and growth rates have been mostly negative over the past few months. This is happening along with slower (expected) general economic growth.

Source: Author's Spreadsheets (Data: University of Michigan)

I often end articles by mentioning that I will be on the sidelines. It does not make too much sense to add to consumer stocks in a situation where general consumer sentiment is peaking. However, I like Five Below a lot. Not only because the company's fundamentals are absolutely amazing. I also like that the company has a ton of potential left in its domestic expansion. Additionally, the company is operating in a segment that tends to suffer less during times of slower consumer sentiment.

I expect Five Below to outperform its peers on the long run. In this case, I am using the retail ETF (XRT) to display the 'average' retail stock. The graph below shows the ratio spread between Five Below and XRT.

Source: TradingView

Takeaway

Five Below is an impressive retailer. Everything seems to go right. Sales are strong, comps are as solid as it gets and margins are strong. Even the ugly post-earnings sell-off was not able to do serious damage to long-term holders as the stock is still up more than 55% year-to-date.

Personally, I am looking to buy this stock as low as possible. For now, I am cautious given that general economic conditions are not getting better. Once we get signs that the consumer is gaining momentum again, I will make this one of my biggest holdings as I am convinced that this business model and management will continue to deliver strong results in the long-term.

I'll keep you updated!

Thank you for reading my article. Please let me know what you think of my thesis. Your input is highly appreciated!

Disclaimer: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.

Disclosure: I/we 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.