EUR 850.00 For Business Accounts Only

Morningstar | After a Strong 3Q, Our Outlook Is Favorable for Five Below, but Shares Still Seem Rich

Considering third-quarter results that leave it ahead of our full-year expectations, we anticipate a low-to-mid single-digit percentage uptick for our $89 per share valuation for no-moat Five Below. We still have a favorable view of the firm's growth prospects, particularly given its strong management team and prudent expansion strategy. Still, we anticipate the competitive environment will limit long-term adjusted operating margins to levels near fiscal 2017's 12% mark, despite low- to mid-teens store growth-fueled top-line growth over the next decade. Consequently, the shares strike us as somewhat rich.

Five Below's 4.8% third-quarter comparable-store sales growth outpaced our 3.5% mark, with the firm's year-to-date results showing 24% top-line growth against a 7.4% adjusted operating margin. Management lifted its fiscal 2018 EPS target to $2.60 to $2.64 from $2.51 to $2.57, assuming $1.550 billion to $1.557 billion in sales and 3.3% to 3.7% comparable-store sales growth (up from $1.528 billion to $1.540 billion and 2.5% to 3%, respectively). Our pre-announcement forecast called for $1.536 billion in revenue and $2.55 in adjusted EPS.

We believe the results are emblematic of management’s strong, consistent execution, characterized by prudent expansion (executing several store openings concurrently in a new area to quickly build expense leverage) and strong operational results. With other physical retailers’ struggles, we anticipate ample attractive locations will be available for the chain’s continued expansion.

Still, continued agitation over trade reflects the degree to which the firm relies on inexpensive global sourcing to deliver value. With competition intense and multifaceted (coming not just from rival retailers but also entertainment and other alternatives meant to mollify preteens and teens), tariffs can create an asymmetric burden. The competitive dynamic keeps us from concluding that Five Below enjoys an economic moat despite its strong record.