Fred's Inc.’s (FRED) third-quarter fiscal 2014 loss of 16 cents was wider than the Zacks Consensus Estimate of a loss of 14 cents. The results compared unfavorably with earnings of 20 cents reported a year ago as well as the company’s expectation of incurring loss in the range of 5 to 11 cents. Softer comps and weak margins resulted in the disappointing results.
The third-quarter results exclude provisions to reserve impacts and non-operational charges. In the second quarter, Fred’s planned to shut down stores which did not meet its operational targets under its -year reconfiguration plan announced in fiscal 2012. Per this strategy, the company closed five stores in the third quarter. The reported results also exclude provisions to establish reserves for closed-store inventory and additional above-cost markdowns on low-productive inventory.
Fred’s embarked on a 3-year reconfiguration plan in fiscal 2012 to enhance its focus on higher-margin categories and move away from the lower-margin consumable categories. The company is remodeling and refreshing its store layouts and allocating space to highlight the key revenue-generating categories.
Soft Revenues and Margin
Total third-quarter sales increased 3% to $476.2 million from $460.5 million in the year-ago quarter. Sales, however, beat the Zacks Consensus Estimate of $469.0 million by 1.5%. Comparable store sales increased 0.3% lower than an increase of 1.4% in the year-ago period.
Sales of segments like Household goods, Apparel and linen, Paper and chemical and Food and tobacco declined from the last year. However, Pharmaceuticals sales improved driven by Fred’s’ goal to increase pharmacy penetration in its stores.
Gross margin shrank 250 basis points (bps) to 27.1% of sales, excluding the impact of the inventory provision. Margins were affected by continuing pressure on pharmacy initial markups following generic inflation And markdowns on general merchandise due to promotional discounts given by the company with the aim to reduce inventory.
As a result, selling, general and administrative (SG&A) expenses increased to 29.4% of sales, up 120 bps year over year. Disciplined expense management was offset by higher occupancy-related costs and transitional expenses associated with the restructuring of Fred’s’ store models. The company incurred operating loss of $16.6 million compared to an income of $10.6 million a year ago.
During the quarter, Fred's opened six Xpress pharmacy locations while closing two in addition to five full-service stores.
Strategic Initiatives to Improve Sales
Fred’s plans to accelerate its pharmacy acquisition to achieve its target of reaching 65% to 70% penetration rate of stores with a pharmacy. The company also plans to initiate a new marketing plan, directed at driving customer traffic through multiple avenues, including expanded ad circulars and in-store programs.
Fourth-Quarter Fiscal 2014 Outlook
The Zacks Rank #5 (Strong Sell) company provided a conservative outlook for fourth-quarter fiscal 2014. Fred’s expects total sales to increase in the range of 4% to 6% on a year-over-year basis. Comparable store sales are expected to remain within the range of flat to up 2% from the year-ago level. Loss per share is forecasted in the range of 8 to 12 cents compared with earnings of 11 cents in the same quarter last year. The loss per share guidance fell short the Zacks Consensus Estimate of a loss of 2 cents.
Some better-ranked stocks to consider in the retail industry include Hanesbrands Inc. (HBI), Michael Kors Inc. (KORS) and Nike Inc. (NKE). While Hanesbrands and Nike sport a Zacks Rank #1 (Strong Buy), Michael Kors carries a Zacks Rank #2 (Buy).
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