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Morningstar | Execution Remains Strong at Five Below as First-Half Results Shine, but the Shares Strike Us as Rich

With narrow-moat Five Below benefiting from its differentiated concept and strong retail conditions, we plan a high-single-digit percentage uptick for our $76 per share valuation. However, while it continues to leverage its emerging scale and strong merchandising capabilities, we contend that trading levels seem to assume perfection, so we counsel patience for investors considering a position. As we attribute recent strength to cyclical factors, we still expect sales growth tapering into the high single digits against adjusted operating margins near fiscal 2017's 12% mark over our 10-year explicit forecast.

In the first half, revenue rose 25% on 3% comparable-store sales growth against an 8.6% adjusted operating margin. Management lifted its fiscal 2018 EPS target to $2.51 to $2.57 from $2.42 to $2.48, assuming $1.528 billion to $1.54 billion in sales from 2.5% to 3% comparable-store sales growth. Our preannouncement marks were more conservative, calling for $1.522 billion in revenue and $2.47 in adjusted EPS.

With retail conditions strong, we believe Five Below has capitalized well on its on-trend offering to maintain momentum at its value-oriented prices despite reasonably healthy consumer pocketbooks. Its flexible sourcing demonstrated itself again as management discussed plans to boost shelf space dedicated to toys as Toys R Us' demise has led to excess available merchandise. We support the move, particularly as Five Below has long catered to younger consumers successfully. While the change should not materially affect our forecast, we contend that it demonstrates Five Below's ability to capitalize on fast-changing retail conditions, a characteristic of the broader channel. Still, we suspect that robust consumer spending is concealing competitive pressure that will re-emerge in more normal markets. While we expect the off-price channel is better insulated against the digitization of retail than most, we anticipate the strain will limit profitability growth.