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On Apr 2, Zacks Investment Research downgraded Fred’s Inc. (FRED - Analyst Report) to a Zacks Rank #5 (Strong Sell). A disappointing fourth quarter fiscal 2012 and a weak view for the upcoming quarter are the reasons for downgrade.

Why the Downgrade?

On Mar 28, Fred's posted fourth-quarter fiscal 2012 (ended Feb 2013) earnings of 18 cents per share, missing the Zacks Consensus Estimate by a penny and the guidance range of 31 cents to 36 cents per share. Earnings declined 30.7% from the prior-year quarter due to the ongoing tough retail environment, challenging results in general merchandise departments and higher operating expenses.

Sales also missed the Zacks Consensus Estimate of $534.0 million but increased 7% year over year to $533.4 million. However, excluding the extra week in the current quarter, comparable store sales declined 2.8% compared to an increase of 0.1% in the same quarter last year, while comparable store customer traffic decreased 2.8% from last year.

The company’s gross margin expanded 20 basis points to 27.9% in the quarter driven by higher pharmacy department margins. However, decreased margins in the general merchandise department due to a sales mix shift significantly impacted the quarter. Operating margin shrank 70 basis points to 2.0% due to higher selling, general and administrative, store occupancy costs and insurance costs.

Management expects tough retail conditions to continue across the markets in fiscal 2013. The company anticipates poor weather in March, which will impact comparable store sales in the first quarter. The company thus expects comparable store sales to decline in the range of 1% to 3%, compared with a decrease of 0.3% in the first quarter of fiscal 2011. Fred’s also expects earnings for the first quarter in the range of 26 to 30 cents compared with 28 cents reported last year.

This general merchandise retailer has witnessed sharp downward estimate revisions after announcing its fourth-quarter fiscal 2012 results. Most of the estimates declined for the first quarter over the past 30 days and the Zacks Consensus Estimate decreased 12.9% to 27 cents per share. For fiscal 2013, all the estimates were revised downward over the same time frame, sinking the Zacks Consensus Estimate by 17.8% to 83 cents per share.

Other Stocks to Consider

Not all stocks are performing as poorly as Fred’s. Other retailers with favorable Zacks Rank include Sears Holding Corp (SHLD - Analyst Report), Macy’s Inc (M - Analyst Report) and Costco Whole Corp (COST - Analyst Report). While Sears and Macy’s hold a Zacks Rank #1 (Strong Buy), Costco carries a Zacks Rank #2 (Buy).

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