What happened
Shares of Five Below (FIVE -0.51%) fell 17.5% in August, according to data provided by S&P Global Market Intelligence. The company is a brick-and-mortar chain that offers low-priced items, largely to teens and preteens.
It reported quarterly financial results during the month that were in line with expectations. But management made some modifications to its guidance based on industry headwinds, and the market didn't like it.
Five Below reported financial results for the fiscal second quarter of 2023 on Aug. 30. Q2 net sales of $759 million and net income of $46.8 million were both within management's guidance, so this much was fine. Moreover, management maintained its full-year net sales guidance, which was reassuring for investors.
However, Five Below lowered its guidance for its full-year profits due to an increase in organized theft, which is what the market was worried about.
So what
Many retailers, including Target, have noted elevated "shrinkage" in stores -- inventory that's unaccounted for, often due to theft. Sales can hold up just fine. But if your company paid for inventory that's now missing, it lowers profits.
For Five Below, it's not seeing much pressure from inventory shrink yet. But given that this is an industry-wide problem, management is taking the situation seriously. It's already started implementing some things that should help cut down on shrink.
Still, even with what it is doing to address the problem, Five Below's management still expects shrink to hit its profits. Previously, it guided for full-year net income of $297 million to $319 million. But now it anticipates net income of $295 million to $311 million. And this appears to be what the market didn't like.
Investors' expectations also factor into this discussion. In 2022, logistic expenses ate into profits margins, and this pressure was supposed to alleviate this year, allowing margins to rebound. Indeed, logistic expenses have gone down. But now this new issue of shrink is keeping margins from bouncing back as expected.
Now what
I think we can all agree that the potential impact to Five Below's profits is incredibly small. It's true that the company will need to work through this moving forward. But the issue looks small and temporary to me, which may make the stock's fall in August a gift for long-term investors.
Five Below expects to open around 2,000 new stores over the next seven years. And new stores have a payback period of less than one year -- profits cover the expenses of opening up in under 12 months. Therefore, I expect net sales and profits to steadily climb from here, and shares of Five Below will likely trend higher as well as a result.
In any given quarter, Five Below will have challenges to overcome, as it does now with inventory shrink. But the business has created a lot of shareholder value over the years, and the trend looks poised to continue.
