Five Below Earnings: Decent Quarter Shows Shoppers Continue To Respond To Value; Shares Rich

We do not plan to change our $148 per-share valuation for no-moat Five Below FIVE significantly after it announced first-quarter earnings, with time value of money-related adjustment offsetting the impact of modest sales underperformance. Nevertheless, we see the results as decent considering macroeconomic headwinds have strained discretionary spending. Consequently, our long-term forecast remains in place (low-double-digit annual sales growth rates and operating margins over the next decade). With the shares rallying modestly in after-hours trading (partly, we suspect, out of relief that Five Below was spared the worst of mix and traffic problems that plagued firms like narrow-moat Dollar General), we suggest investors await a more attractive entry point, as the shares appear to be priced assuming perfect execution in what should remain an intensely competitive retail landscape.

Comparable sales rose 2.7%, modestly below our 3.5% target as consumers faced smaller-than-usual tax refunds and continued pressure from high prices for consumables. The sales underperformance led Five Below’s operating margin to modestly undershoot our 6.0% target, at 5.8%, due to more muted cost leverage. The company tightened its full-year diluted EPS guidance to $5.31-$5.71 (previously $5.25-$5.76), and our $5.65 estimate is within the new range.

The company’s 3.9% traffic growth was encouraging, showing that consumers continue to respond to the chain’s value proposition despite discretionary income pressures. Although we do not believe the firm’s assortment or store experiences are sufficiently differentiated to warrant an economic moat, management has executed well, and we are encouraged by the company’s strong performance of new store openings. We continue to see significant room for growth, with our forecast assuming Five Below expands to roughly 4,000 stores over the next decade, around three times its present size.