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Five Below Has Some Big Questions to Answer for Investors This Week

By Demitri Kalogeropoulos – Aug 30, 2020 at 12:00PM

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Did the chain avoid the type of inventory pressure that has hurt rivals in recent weeks?

Investors' attitudes about Five Below (FIVE -0.49%) have improved sharply in the last few months. While the stock is still trailing the market in 2020, its losses are much improved from the 60% declines Wall Street saw in mid-March.

The retailer's subsequent rally will be put to the test this week, when the chain reports fiscal second-quarter results and comments on its inventory, cash, and sales trends heading into the key holiday shopping season.

Let's take a closer look at what to expect from that announcement, set for Wednesday, Sept. 2.

Three young women shopping together.

Image source: Getty Images.

Sales trends

The chain is still likely to see an impact from its COVID-19-related store closures that started on March 20. Its locations began reopening in late April and nearly all stores were welcoming customers by early June. Yet a significant portion of its base was closed for part of the quarter, which runs from early May through early July.

Look for Five Below to improve on the 52% slump it reported last quarter. Most investors who follow the stock are predicting only modest sales losses this week, with revenue dropping just 2% to $410 million. CEO Joel Anderson and his team said back in June that executives were "very pleased" with early sales trends as stores reopened. However, retailers including TJX Companies have recently announced that growth tapered off following an initial growth surge. We'll learn on Wednesday whether Five Below's business was hurt by the same challenge.

Pricing challenges

Five Below likely endured several negative trends that pushed its profitability lower over the last few months. Besides the soft customer traffic, the chain surely had to cut prices on inventory that had missed its prime selling window in April and May. Those inventory challenges could have been amplified by industry peers all seeking to slim down their holdings at the same time.

The metrics to watch in this area include gross profit margin, which dove to 10% of sales last quarter from 33% a year ago. A quick rebound would imply Five Below is in a strong inventory position today. Another soft result, on the other hand, suggests bloated inventory heading into the key holiday shopping season.

Looking ahead

Management probably isn't in a position to reinstate any kind of short-term growth outlook given the questions around back-to-school shopping, additional COVID-19 outbreaks, and the economic health of consumers. Industry peers including Target and Walmart all declined to issue new operating forecasts in recent weeks.

But Anderson and his team should have enough information by now to narrow down Five Below's wide range of contingency plans for late 2020. If the biggest financial risks have passed, look for the retailer to announce more aggressive investments into business, including a plan for stepped-up store launches beginning in 2021.

The chain's most attractive growth avenue is its potential to reach at least 2,500 stores over time, compared to less than 1,000 today. Investors will be eager to see signs that Five Below can continue marching toward that ambitious goal with at least 100 new locations added to the base each fiscal year.

Demitri Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Five Below and The TJX Companies and recommends the following options: long January 2022 $115 calls on Five Below and short January 2022 $120 calls on Five Below. The Motley Fool has a disclosure policy.

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