Five Below’s Expansion Strategy Goes Into Overdrive

Investors had high expectations heading into Five Below‘s (NASDAQ:FIVE) earnings report this past week. Despite COVID-19 challenges, the retailer entered the holiday shopping period with growth momentum that implied a great finish to a turbulent year.

Its actual results gave investors more reasons to feel optimistic about the business, whether it’s the potential for rising profitability or dramatically higher sales over the long term. Let’s take a closer look.

A young woman holding shopping bags on a mall escalator.

Image source: Getty Images.

Beating expectations

Five Below surpassed even the updated outlook that management issued in its mid-quarter announcement. Revenue rose 25% through the holiday period and comparable-store sales, or sales at existing stores, jumped 13%. That result matched the company’s prior-quarter uptick and outperformed the 11% target that executives issued back on Jan. 12.

The boost ensured that sales rose 6.2% for the full year, or about a full percentage point higher than management predicted. “We closed out an unprecedented year with fourth quarter results that were even strong than we expected,” CEO Joel Anderson said in a press release.

Annual sales growth slowed considerably when compared to 2019’s near-20% increase, but the results have to be considered a win considering that stores were closed for several weeks and retailing traffic was pressured by social distancing for most of the year.

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Rising prices

Profitability dropped slightly but remained strong through the competitive holiday shopping season. Five Below has been expanding its offerings to higher-priced products like consumer electronics, toys, and games. The strategy resonated with its younger shopping demographic so that gross profit margin only declined to 33% of sales for the full year from 36% in 2019.

Management said that demand was strong across all of Five Below’s retailing niches. Earnings were $2.20 per share for full-year 2020, surpassing the high end of the guidance range the company issued in mid-January.

Looking forward

All of this success apparently convinced management to push its expansion strategy up to a higher level. The company is planning to open 60 new locations in the fiscal first quarter compared to just 38 in the past two quarters.

Five Below launched 120 new stores through all of 2020 but is predicting a quick return to a faster growth pace, perhaps outstripping the 150 openings it achieved in fiscal 2019. Many of those new stores will include a wider selection of higher-priced offerings (above $5 each), which management calls its “Five Beyond” approach.

The retailer will soon be operating in 40 states around the country after adding Utah and New Mexico in early 2021. Yet today it is running less than half of the 2,500 locations that management sees as a reasonable long-term goal.

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A major investor concern about that ambitious target has been the potentially risky, trend-chasing aspect of Five Below’s merchandising approach. But the retailer has found ways to use that model to boost customer traffic for several years now, including through the wild selling conditions that characterized most of 2020.

After a strong finish to that year, shareholders have to be feeling more confident that Five Below has a good shot at building a larger sales footprint in 2021 and beyond.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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