Five Below's (NASDAQ:FIVE) recent earnings report seemed to hit all of the notes that investors wanted to hear. The retailer's sales shot up by almost 30% and earnings more than doubled in the first quarter. Better still, since both the top- and bottom-line figures beat management's expectations, executives raised their 2018 outlook on both counts.

Shares soared in response to the news, but there are some good reasons for investors to temper their enthusiasm about this trendy business.

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Modest sales growth

Five Below's sales gains weren't as impressive as they might seem at a glance, for example. The 27% revenue spike was mostly powered by the retailer's quickly growing store base. Sales at existing locations rose by a more modest 3.2% that was actually near the low end of the guidance range that management issued back in late March.

And that comparable-store sales uptick wasn't particularly strong, either. In a conference call with investors, CEO Joel Anderson and his team explained that the increase was driven entirely by higher average spending, with customer traffic declining slightly during the period. Five Below suffered from the same weather-driven traffic challenges that other retailers witnessed. It also had to deal with tough comparisons with a prior-year period that included unusually strong demand around what management describes as the "spinner craze."

Profitability updates

The profit performance was solid, but unspectacular, too. Sure, gross profit margin expanded to 32.8% of sales from 31.7%. This improvement combined with decreased selling and administrative expenses to push operating income up to 8.3% of sales from 5.5% of sales a year ago.

However, Five Below had some unusually high costs in the year-ago period related to employee incentives and the retailer's initial push into the California market. These investments reduced gross profitability and raised expenses last year, which made it that much easier to post improvements in these metrics this time around.

Steady outlook

In fact, Anderson and his team are still forecasting a modest profitability decline in each of the next three quarters, just as they did back in March. The slight increase in expected earnings, meanwhile, likely has to do with the fact that management sees the tax rate falling to 23.5% for the year, rather than the 24.5% rate they had previously estimated.

Five Below didn't materially change its sales growth outlook, either. Comps are expected to be flat in the second quarter as the company continues to face challenges tied to the prior year's strong demand for spinners. Sales at existing locations are still expected to rise by between 1% and 2% for the full year while the addition of 125 stores pushes overall revenue up by approximately 20%.

Those top- and bottom-line forecasts are healthy, and they both support management's aggressive investment thesis that sees Five Below's store base rising to as many as 2,500 locations over the long term, up from 650 today. The retailer appears to have plenty of room to march toward that goal as it expands beyond its current 32-state presence.

But the first-quarter results didn't lift the company above the trajectory that investors have been watching for several quarters now, either. Five Below is still enjoying positive momentum that should protect its impressive streak of 20% annual sales gains. Its soft customer traffic numbers and modest profitability gains, meanwhile, paint the picture of a company that's doing its best to deal with the same demand challenges that are impacting other retailers in the industry.

 

Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Five Below. The Motley Fool has a disclosure policy.