Fred's Inc (FRED) Q3 Loss Wider Than Expected, Sales Beat

After reporting positive surprises for the past two quarters, Fred's, Inc.’s (NASDAQ:FRED) slipped to loss in third-quarter 2016. The company’s quarterly loss of 27 cents per share was wider than the Zacks Consensus Estimate of a loss of 17 cents. The company had reported earnings of 10 cents a year ago.

The dismal performance weighed upon the stock and its price dipped 3.6% in the pre market trading on Dec 9, 2016, a day after the company released its earnings. In fact so far this year the shares of the company declined 34.7% underperforming the Zacks categorized Retail-Discount & Variety industry which gained 7.64% in the same time frame.

Revenues & Margins

Third-quarter sales slipped 4.5% year over year to $516.6 million but inched past the Zacks Consensus Estimate of $513 million by 1%.

Comparable store sales dipped 3.8%, comparing unfavorably with a 2% decline recorded last quarter. Further, results compared unfavorably with a gain of 2.7% reported a year ago. The downside was due to lower-than-expected comps in front store, retail pharmacy and specialty pharmacy.

Front Store comps dropped 4.3% due to loss of sales in key categories that were involved in the transition to a third-party distributor. Moreover, the comps were negatively affected by impact of the loss of Supplemental Nutrition Assistance Program (SNAP) benefits for core customers, Halloween shift to the fourth quarter and an unusual warm weather.

Retail pharmacy comps were down 2.9% year over year and specialty pharmacy comps declined 2.2% year over year mainly due to reimbursement pressure.

Gross profits slumped 21.8% year over year to $111.2 million. Gross margins contracted 480 basis points (bps) to 21.5% primarily due to soft sales and continued reimbursement pressure in the pharmacy category.

Selling, general and administrative expenses expanded 410 bps to 30% of sales mainly due to a decrease in sales volume in 2016, partially offset by a decline in insurance expenses as well as lower labor expenses due to implementation of pharmacy labor optimization initiatives.

In the third quarter, Fred’s incurred an operating loss of $44.1 million, compared to an operating income of $2.4 million incurred a year ago.

November Sales

In November, sales dipped 3.6% to $159.7 million and comps declined 2.9% against an increase of 1.7% in Nov 2015 mainly due to lower comps in retail front stores.

Store Update

As of Oct 29, 2016, Fred’s operates 647 discount general merchandise stores and three specialty pharmacy-only locations in 15 states in the southeastern United States including 18 franchised locations.

Looking Ahead

For 2017, Fred’s anticipates to incur additional expense related to consulting, employee insurance, software licensing and advertising. The company plans to make significant investments in new stores, remodeling, file buys and maintenance CapEx for the next two years. Fred’s intends to close 40 underperforming stores in first-half 2017.

Zacks Rank & Stocks to Consider

Fred’s currently carries a Zacks Rank #5 (Strong Sell).

Some better-ranked stocks in the same sector are Big Lots Inc. (NYSE:BIG) , Target Corporation (NYSE:TGT) and Ross Stores Inc. (NASDAQ:ROST) . All three stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Big Lots has an expected earnings growth rate of 13.5%.

Ross Stores has an expected earnings growth of 11.4% while Target Corporation has an expected earnings growth of 8.05%.

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