The discount retail niche has been extremely lucrative for general audiences, and so it only made sense for companies to look for ways to narrow the focus of discount retail to teens. Five Below (NASDAQ:FIVE) has a history of catering to the changing trends of fickle teenage shoppers, and coming into Wednesday afternoon's fiscal second-quarter report, Five Below investors wanted to see evidence that the retailer would continue to produce strong growth in revenue. Instead, Five Below fell short of what investors were expecting, and with the stock still sporting a rich valuation, the fallout on its share price was immediate. Let's look more closely at Five Below's latest quarter and why things aren't looking as good for the teen retailer as they have in past periods.
Why Five Below disappointed investors
The problem that most high-growth companies eventually run into is sustaining high growth rates as they get bigger, and Five Below proved vulnerable to that phenomenon this quarter. Revenue gains of 19.5% to $182.2 million weren't enough to satisfy investors, who had wanted the retailer to post year-over-year growth in the 21% range. Similarly, net income fell 15% to $7.06 million, and that produced earnings of $0.13 per share, down from last year's $0.15 although matching the consensus forecast.
A closer look at Five Below's results shows some of the challenges the retailer is facing. Comparable-store sales grew 3% from last year's fiscal second quarter, which was better than last quarter's weaker number but still slower than high-growth investors prefer to see. Five Below also blamed some of the pressure on operating income, which fell 13%, on its internal investments in a new distribution center, as well as shifts in the way that the company directed its marketing efforts. Gross margins also fell by about half a percentage point, and growth in overhead expenses far outpaced revenue increases to eat further into operating margins.
Nevertheless, Five Below continued to follow its strategy of bulking up its store network. The company went well over the 400 mark in store count during the quarter, with 32 new store openings helping to produce a rise of nearly a fifth in the number of Five Below stores just since this time last year.
CEO Joel Anderson tried to explain the results by pointing out one-time factors he believes won't repeat. "As part of our ongoing test and learn approach around our marketing strategy," Anderson said, "we eliminated a summer circular. Second, we experienced temporary store receipt delays as we moved out of our existing East Coast distribution center." Five Below hopes that it is now well-positioned to deliver solid results for the remainder of the fiscal year.
Can Five Below get back on top?
Investors weren't happy about Five Below's outlook for the fiscal third quarter. Sales guidance for $164 million to $167 million in revenue assumes a 3% to 4% rise in comparable-store sales, but it's below the figure that investors had expected the teen retailer to produce. Similarly, earnings of $0.06 to $0.07 per share would be a penny or two lower than the consensus forecast among investors.
Looking further out, though, Five Below still has the same general high expectations for the full 2015 fiscal year. The discount retailer repeated its guidance for revenue of $820 million to $828 million and earnings of $1.03 to $1.06 per share, and that should keep investors relatively comfortable that the key holiday season will bail out Five Below from any short-term shortfalls in the late-summer quarter.
Five Below investors expressed their displeasure at the company's results by sending shares down sharply, as the stock lost 10% of its value within the first hour of after-market trading following the announcement. As long as Five Below makes good on its promise to produce a full-year turnaround to make up for any shortfall here, then the decline could be a chance for interested investors to get a bargain of their own. Yet if Five Below truly is hitting a growth wall, then this could be the beginning of a tough period for the retailer going forward.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool is short Five Below. The Motley Fool recommends Five Below. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.