Fred's Inc. (FRED) posted adjusted earnings of 14 cents in its second-quarter 2011, in line with adjusted earnings in the prior-year quarter and the Zacks Consensus Estimate.
Taking into account the higher income tax rate, Fred’s net income increased 3% to $5.1 million or 13 cents per share compared with net income of $5.0 million or 13 cents per share in the prior-year quarter.
Fred's results have showed consistent gains in the quarter due to increased customer traffic and comparable pharmacy script counts.
Quarter in Detail
Total sales increased 1% year-over-year to $452.7 million, while it missed the Zacks Consensus Estimate of $455.0 million. In addition, Fred’s comparable store sales declined 0.4% versus a 2.5% increase in the prior-year quarter.
Same-store sales at Fred’s inched up 0.7% in the five-week period ended July 2, 2011, compared with an increase of 1.7% posted in the year-ago period.
June’s comparable store sales met management’s expectations and reflected the volatility of customers' purchase patterns as well as decline in customer sentiment. Total retail sales in June 2011 inched up slightly to $179.0 million from $178.9 million in the year-ago period.
Although the month displayed solid sales at the beginning, sales in the month under review kept dwindling. This drop came on the back of a decline in customer traffic and pronounced paycheck cycle, reflecting a challenging economy that generally follows a recession.
Retail sales of fiscal 2011 stood at $807.0 million, which was 2.0% higher than $792.1 million from the year-ago period. Same-store sales for the period edged up 0.6% compared to 2.3% in the previous year. Sales as on July 1 were the highest single-day amount for the year.
Cost and Margin Performance
Expenses increased in the quarter with cost of goods sold edging up 0.7% to $325.8 million. Selling, general and administrative expenses declined as a percentage of sales from 24.6% to 24.4% in the second-quarter 2011. The results were impacted by increases in fuel, depreciation and amortization expenses, offset by positive expense management of labor, store occupancy costs, and advertising costs.
Gross profit grew 1% to $126.9 million with gross margin unchanged at 28.0%. The quarter was impacted by the pressures of the product mix shift and pharmacy department reimbursement rates, offset by improved markdown and shrinkage performance.
Operating income was approximately flat from the prior-year period totaling $8.3 million. Operating margin was flat at 1.8%.
Other Financial Update
At the end of July 30, 2011, Fred’s had cash and cash equivalents of $46.8 million, almost flat compared to $46.9 million as of July 31, 2010.
During the quarter, Fred's opened two new stores and one pharmacy as part of its 2011 operating plan. One franchise store was closed during the quarter. The company also remodeled and refreshed 68 stores with its new Core 5 elements in the quarter, bringing the total number of stores upgraded to 332 during 2010 and 2011.
Outlook
Management expects tough retail conditions to continue across the markets in 2011 due to ongoing concerns about rising petroleum prices and their macroeconomic effects. Additionally, Fred anticipates improvements from its Core 5 Program, and expects its strategic initiatives and cost reduction programs to maintain profitability compared with last year. Fred thus expects income growth of 10% to 20% for the final two quarters of 2011.
For the third quarter of 2011, Fred forecasts its total sales to increase 2% to 4%, while it expects its comparable store sales to increase 1% to 3% versus an increase of 1.5% in the third quarter last year.
The company expects earnings per share to increase 5% to 15% to a range of 21 cents to 23 cents for the third quarter of 2011, compared with earnings per share of 20 cents in the same period last year. Based on this outlook, management expects its full year 2011 earnings to increase 11% to 17% over last year to a range of 83 cents to 88 cents per share.
Fred's, based in Memphis, Tennessee, operates discount general merchandise stores mainly in southeastern U.S. It offers nationally recognized brands, and private label and lower-priced, off-brand products.
The company’s merchandise mix includes more than 12,000 frequently purchased items, consisting of household goods, apparel, food, tobacco, healthcare and paper products. Some of its retail outlets also feature pharmacies, which offer prescription drugs.
However, the company operates in a highly fragmented industry and faces intense competition from national, regional and local retailing establishments, including department stores, discount stores, discount clothing, grocery and convenience stores and drug stores. Consequently, the company is under severe stress to maintain profitability.
Fred’s faces stiff competition from Dollar General Corporation (DG) and Walgreen Co. (WAG). It currently holds a Zacks #4 Rank. On a long-term basis, we maintain a Neutral rating on the stock, with a short-term Sell rating.
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