Should Investors Be Worried About Five Below’s Sales Declines?

Five Below (FIVE -1.32%) investors had modest expectations heading into the recent earnings results. While the youth-focused retailer had posted strong growth in its last few reports, retail peers have been lowering their 2022 outlooks thanks to slowing economic growth, inflation, and soaring costs.

Five Below said last week that these challenges did affect the selling period that ended in late April. And while management is still bullish about growth over the next several years, executives lowered their official forecasts for 2022.

Let’s dive right in.

Sales trends suggest a slowdown

The main fear heading into Wednesday’s report was that Five Below would see a surprising growth slowdown as consumers constituting their spending patterns. That’s exactly what happened. Comparable store sales fell 4% rather than declining by about 2% as management had predicted.

Net sales landed at $ 640 million, up 7% thanks to an expanding store base. Executives back in late March forecast that revenue would reach between $ 644 million and $ 658 million. “First quarter sales were softer than expected,” CEO Joel Anderson said in a press release.

Management explained in a conference call with analysts that the poor prediction was mainly a consequence of volatility around consumer shopping trends as compared to a year ago when financial stimulus payments were boosting demand. “It’s an extremely hard time to predict exactly what’s going to happen, “Anderson explained.

Soaring costs are eating into margins

The good news is that Five Below outperformed on earnings, which put it ahead of peers like Target and WalmartThese larger chains both reduced their 2022 profit outlooks in their Q1 updates, citing rising costs and increased promotions. Operating profit margin was 7%, down 4 percentage points compared to last year but on par with Five Below’s pre-pandemic profitability.

FIVE Operating Margin (TTM) data by YCharts

On the other hand, earnings trends will likely get worse before they get better. Executives say increased labor and freight costs, combined with sales declines, will produce a bigger profit slump in the next few quarters. That margin hit will be especially hard in the current quarter.

Looking ahead to the rest of 2022 for Five Below

Five Below’s weaker earnings outlook puts it in the same camp as Target in this regard. The chain also faces a similar inventory risk heading into the second half of the fiscal year, which might require markdowns and promotions to keep merchandise moving off the shelves.

Management doesn’t see this bearish scenario playing out right now. Instead, executives say margins should rebound in the holiday quarter. Overall sales and earnings trends are strong compared to pre-pandemic periods, and retail shoppers are still spending and looking for value.

Five Below sees room to roughly triple its store count, preserving its bullish long-term outlook. Shoppers are also embracing its new store format, which includes higher-priced merchandise. These factors suggest a much higher annual sales base over time than the $ 3 billion. that management is currently predicting for 2022.

Executives had described this as a weaker-growth year following soaring results in 2021. This earnings update pertaining a modest downgrade for the short term. Investors will have to wait and see if growth and margin trends improve by the holiday season, as expected, or if Five Below’s slowdown continues through the second half of the year.

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