Five Below Gives Investors More Reasons for Optimism

Five Below (NASDAQ: FIVE) announced earnings results for the second quarter of fiscal 2018 this week, reporting strong sales growth and improving profitability. Back in June, the company had predicted weaker results on both metrics, and so investors were happy to see the company beat its own targets.

In a conference call with Wall Street analysts, CEO Joel Anderson and his team explained the drivers behind Five Below's outperformance, while adding context to their upgraded outlook for the rest of the year. Below are a few key highlights from that presentation:

Beating targets

Three months ago, Five Below issued a conservative outlook that called for flat comps and reduced profitability in the second quarter. Management was right about one key part of the prediction: Customer traffic declined slightly when compared with a prior-year period that was lifted by soaring demand for spinners.

However, the retailer still managed to grow comps by 2.7% this quarter -- on top of the prior year's record 9.3% comp increase -- thanks to higher spending by shoppers. The outperformance here came despite steady pricing trends that lifted gross margin by 0.2 percentage points to 35.0% of sales. Executives credited their buyers' success at packing stores with "fresh, trend-right summer products," along with generally rising traffic at shopping centers across the country.

Adding stores

Few retailers are growing their store footprints as aggressively as Five Below is right now. The youth-focused company has added more than 100 locations over the last year to boost its store base by almost 20%.

The latest crop of new stores has a slightly different layout that executives say makes them more inviting for customers. These locations are rapidly reaching positive returns on investment, and management says they're on track to be the strongest class of launches yet. That's a good sign, considering that the company hopes to more than triple its store count from here over the long term.

Looking forward

Five Below raised its full-year sales target thanks to the rising demand trends at its existing locations. An improving toy business -- which management says is being supported by the liquidation of Toys R Us -- is a key reason behind that upgrade. The loss of that retailer has created another area that Five Below's buyers can target for growth, in addition to things like licensed products (such as Disney's Frozen and Star Wars merchandise). Investors can still expect profitability to decline slightly this year as Five Below spends aggressively in areas like store design and marketing.

Meanwhile, the company plans to open 50 new stores in the current quarter, which would be a record expansion pace. That would leave Five Below at about 750 locations, with plenty of room to grow toward management's long-term target of 2,500 shops nationwide.

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Demitrios Kalogeropoulos owns shares of Walt Disney. The Motley Fool owns shares of and recommends Walt Disney. The Motley Fool recommends Five Below. The Motley Fool has a disclosure policy.