Discount retailer Five Below (NASDAQ:FIVE) missed analysts' expectations in Q2 FY2023, with revenue up 13.5% year on year to $759 million. However, next quarter's revenue guidance of $722.5 million was less impressive, coming in 2.05% below analysts' estimates. Turning to EPS, Five Below made a GAAP profit of $0.84 per share, improving from its profit of $0.74 per share in the same quarter last year.
Five Below (FIVE) Q2 FY2023 Highlights:
- Revenue: $759 million vs analyst estimates of $760 million (small miss)
- EPS: $0.84 vs analyst estimates of $0.83 (1.11% beat)
- Revenue Guidance for Q3 2023 is $722.5 million at the midpoint, below analyst estimates of $737.6 million
- The company reconfirmed its revenue guidance for the full year of $3.54 billion at the midpoint
- Free Cash Flow of $12.6 million is up from -$47.6 million in the same quarter last year
- Gross Margin (GAAP): 34.9%, up from 34.2% in the same quarter last year
- Same-Store Sales were up 2.7% year on year (in line)
- Store Locations: 1,400 at quarter end, increasing by 148 over the last 12 months
Often facilitating a treasure hunt shopping experience, Five Below (NASDAQ:FIVE) is an American discount retailer that sells a variety of products from mobile phone cases to candy to sports equipment for largely $5 or less.
A typical store is around 8,000 square feet in size, located in a suburban shopping center or mall. Overall, stores are bright and colorful, with a layout that encourages customers to browse and discover new products. One prominent section in most stores is tech, where customers can find headphones, charging cables, and phone cases. There is also usually a section for beauty and personal care products. Toys and snacks are two other prominent sections, with the latter located near the checkout area to encourage impulse purchases.
The company's core customer base is young adults and teenagers who are looking for affordable yet trendy products. For example, when the colorful rubber ‘pop it’ or ‘push pop’ product became popular among children, Five Below jumped on the trend and featured the products prominently in its toy sections. This customer base also values the treasure hunt experience of walking a Five Below store. So while the store’s sections are consistent, the products sold in each section may vary over time and will depend on what’s hot and what the company can source and sell within its price and margin guardrails.
Broadline discount retailers understand that many shoppers love a good deal, and they focus on providing excellent value to shoppers by selling general merchandise at major discounts. They can do this because of unique purchasing, procurement, and pricing strategies that involve scouring the market for trendy goods or buying excess inventory from manufacturers and other retailers. They then turn around and sell these snacks, paper towels, toys, and myriad other products at highly enticing prices. Despite the unique draw and lure of discounts, these discount retailers must also contend with the secular headwinds of online shopping and challenged retail foot traffic in places like suburban strip malls.
Retail competitors include TJX (NYSE:TJX), Urban Outfitters (NASDAQ:URBN), and Ollie’s Bargain Outlet (NASDAQ:OLLI).Sales Growth
Five Below is a mid-sized retailer, which sometimes brings disadvantages compared to larger competitors benefiting from better economies of scale. On the other hand, it has an edge over smaller competitors with fewer resources and can still flex high growth rates because it's growing off a smaller base than its larger counterparts.
As you can see below, the company's annualized revenue growth rate of 17.7% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was excellent as it added more brick-and-mortar locations and increased sales at existing, established stores.
This quarter, Five Below's year-on-year revenue growth clocked in at 13.5%, falling short of Wall Street's estimates. The company is guiding for revenue to rise 12% year on year to $722.5 million next quarter, improving from the 6.15% year-on-year increase it recorded in the same quarter last year. Looking ahead, the analysts covering the company expect sales to grow 17.6% over the next 12 months.
Number of Stores
A retailer's store count is a crucial factor influencing how much it can sell, and store growth is a critical driver of how quickly its sales can grow.
When a retailer like Five Below is opening new stores, it usually means that demand is greater than supply, and in turn, it's investing for growth. Five Below's store count increased by 148 locations, or 11.8%, over the last 12 months to 1,400 total retail locations in the most recently reported quarter.
Over the last two years, the company has opened new stores rapidly, averaging 12.8% annual growth in its physical footprint. This store growth is among the fastest in the consumer retail sector. With an expanding store base and demand, revenue growth can come from multiple vectors: sales from new stores, sales from e-commerce, or increased foot traffic and higher sales per customer at existing stores.
Same-Store Sales
Same-store sales growth is an important metric that tracks demand for a retailer's established brick-and-mortar stores and e-commerce platform.
Five Below's demand within its existing stores has generally risen over the last two years but lagged behind the broader consumer retail sector. On average, the company's same-store sales have grown by 2.57% year on year. With positive same-store sales growth amid an increasing physical footprint of stores, Five Below is reaching more customers and growing sales.
In the latest quarter, Five Below's same-store sales rose 2.7% year on year. This growth was a well-appreciated turnaround from the 5.8% year-on-year decline it posted 12 months ago, showing that the business is regaining momentum.
Gross Margin & Pricing Power
As you can see below, Five Below has averaged a mediocre 34.9% gross margin over the last two years. This means the company makes $0.35 for every $1 in revenue before accounting for its operating expenses. 
Five Below's gross profit margin came in at 34.9% this quarter, relatively flat with the same quarter last year. This steady margin could stem from its efforts to keep prices consistently low or signal that it has stable input costs (such as freight expenses to transport goods).
Operating Margin
Operating margin is an important measure of profitability for retailers as it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.
In Q2, Five Below generated an operating profit margin of 7.72%, down 0.7 percentage points year on year. Conversely, the company's gross margin actually increased, so we can assume that the reduction was driven by inefficient cost controls or lower operating leverage on fixed costs.
From an operational perspective, Five Below has done a decent job over the last eight quarters. The company has produced an average operating margin of 9.71%, higher than the broader consumer retail sector. On top of that, its margin has remained more or less the same, highlighting the consistency of its business. The company's profitability was particularly impressive because of its low gross margin. This margin is mostly a factor of what Five Below sells and it takes tectonic shifts to move meaningfully. Companies have more control over their operating margins, and it signals strength if they're high when gross margins are low (like for Five Below).EPS
Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.
In Q2, Five Below reported EPS at $0.84, up from $0.74 in the same quarter a year ago. This print beat Wall Street's estimates by 1.11%, a welcome development that should delight shareholders.
Between FY2020 and FY2023, Five Below's adjusted diluted EPS grew 120%, translating into a striking 40% average annual growth rate. This growth is materially higher than its revenue growth over the same period, indicating that Five Below has excelled in managing its expenses (leading to higher profitability), bought back a healthy chunk of its outstanding shares (leading to higher PER share earnings), or did some combination of both.
Cash Is King
Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.
Five Below's free cash flow came in at $12.6 million in Q2, representing a 1.67% margin and flipping from cash flow negative in the same quarter last year to cash flow positive. This was an awesome development for the business.
Over the last two years, Five Below's capital-intensive business model and large investments in new store buildouts have consumed many company resources. Its free cash flow margin has averaged negative 0.67%, weak for a consumer retail business. However, its margin has averaged year-on-year increases of 5.5 percentage points. Investors should feel relieved as this is certainly a step in the right direction.
Return on Invested Capital (ROIC)
Five Below's subpar returns on capital may signal a need for future capital raising or borrowing to fund growth. Its five-year average return on invested capital (ROIC) is 11.3%, somewhat low compared to the best retail companies that consistently pump out 25%+ returns.
We like to track ROIC because it tells us about a company’s prospects for profitable growth and its management team's ability to achieve it through capital allocation decisions such as organic investments, acquisitions, and share buybacks. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from Five Below's Q2 Results
With a market capitalization of $10.2 billion, a $436.4 million cash balance, and positive free cash flow over the last 12 months, we're confident that Five Below has the resources needed to pursue a high-growth business strategy.
Revenue missed, but EPS beat in the quarter. Gross margin increased year on year, which was a positive. On the other hand, while Five Below's full-year revenue guidance was maintained, it missed analysts' expectations. The company also reduced full year EPS guidance due to an increase in "shrink reserves", and this reduction is likely a major cause of the stock's weakness. Overall, the results could have been better. The company is down 6.24% on the results and currently trades at $171.4 per share.
Is Now The Time?
When considering an investment in Five Below, investors should take into account its valuation and business qualities as well as what happened in the latest quarter. Although we've other favorites, we understand the arguments that Five Below isn't a bad business. Its revenue growth has been impressive, and analysts believe that sort of growth is sustainable for now. And while its mediocre same-store sales performance has stunted total revenue growth, the good news is its new stores openings has increased its brand equity.
There are things to like about Five Below and there's no doubt it's a bit of a market darling, at least for some investors. But it seems there's a lot of optimism already priced in and we wonder whether there might be better opportunities elsewhere right now.
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