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Fred’s Inc (FRED - Analyst Report) is set to report second quarter fiscal 2013 results on Aug 29. Last quarter, it posted a 10.7% positive surprise. Let’s see how things are shaping up for this announcement.

Why a Likely Positive Surprise?

Our proven model shows that Fred’s is likely to beat earnings because it has the right combination of two key ingredients.

Positive Zacks ESP: The expected surprise prediction or ESP (Read: Zacks Earnings ESP: A Better Method), which represents the difference between the Most Accurate estimate and the Zacks Consensus Estimate, is +11.11%. This is meaningful and a leading indicator of a likely positive earnings surprise for the shares.

Zacks Rank #3 (Hold): Fred’s carries a Zacks Rank #3 (Hold). Note that stocks with a Zacks Rank #1, #2 and #3 have a significantly higher chance of beating earnings estimates. The sell rated stocks (#4 and #5) should never be considered going into an earnings announcement. 

The combination of Fred’s Zacks Rank #3 (Hold) and a positive ESP of +11.11% makes us confident of an earnings beat on Aug 29.

What is Driving the Better-than-Expected Earnings?

We believe that the company’s strategic turnaround initiatives to improve its same-store sales will be the driving factor in the second quarter.

After suffering from declining same-store sales for several months, Fred’s embarked on a 3-year reconfiguration plan in early June.

As part of this plan, Fred’s shifted its focus to higher margin categories from lower-margin consumable categories. Fred’s is remodeling and refreshing its store layouts and allocating space for the key revenue-generating categories. Moreover, keeping in view the substantial contribution of the pharmacy department in its operating income, Fred’s is expanding the department in all its stores. The initiatives are already bearing fruit as the company posted decent total and comparable sales for the months of Jun and Jul 2013. We believe the initiatives will continue to deliver solid comps growth in the second quarter.

Other Stocks to Consider

Here are some other companies in the retail sector that can be considered as our model shows that they have the right combination of elements to post an earnings beat this quarter:

Dollar General Corp (DG - Analyst Report), Earnings ESP of +1.35% and a Zacks Rank #2 (Buy).

Costco Wholesale Corp (COST - Analyst Report), Earnings ESP of +0.69% and a Zacks Rank #3 (Hold).

Dollar Tree Inc. (DLTR - Analyst Report), Earnings ESP of +1.70% and a Zacks Rank #3 (Hold).

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