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Fred's (FRED) Q1 Loss In Line, Sales Weaker than Expected

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Fred's, Inc. FRED or Fred’s Pharmacy posted weaker-than-expected sales in the first quarter of fiscal 2017, while losses were in line with the Zacks Consensus Estimate. The company’s share price slumped 11.99% after market closing on Jun 6, 2017.

Quarterly Results

The discount retailer posted adjusted quarterly loss of 6 cents per share, which was in line with the Zacks Consensus Estimate. It was unfavorable compared with the year-ago quarter figure 3 cents. Decline in sales along with lower comps and gross margin contraction led to the decline.

Revenues & Margins

First-quarter sales slipped 3.1% year over year to $532.2 million and also marginally lagged the Zacks Consensus Estimate of $533 million by 0.2%. Comparable store sales dipped 1.2%, narrower than a 3.6% decline recorded in the preceding quarter. However, results compared unfavorably with a gain of 1.0% reported a year ago. Comps declined as a result of the sale of low productive discontinued inventory. The company is also facing headwinds in the competitive consumable categories

Gross profits declined 5.9% year over year to $132.9 million, while gross margins declined 70 basis points (bps) to 25.0%, due to the closure of 39 underperforming stores. In the first quarter, Fred’s incurred an operating loss of $34.2 million, compared with an income of $2.4 million incurred a year ago. Losses were due to higher selling, general and administrative expensesmainly due to higher professional, legal, banking and integration planning fees incurred in connection with the announced agreement to acquire Rite Aid stores and the development and implementation of the company's growth strategy.

In fact, we note that in the past six months, the company’s shares have been gaining momentum significantly. The company started to recognize the positive impact of the initiatives it began implementing in 2016. Shares have increased 10.3% outperforming the Zacks categorized Retail-Discount & Variety industry which declined 4.2% over the same time frame. Further, we believe there is room for further upside which is also evident from its Momentum Score of ‘A’ and long-term earnings growth rate of 8.00%.

We note that despite dismal first-quarter results, the company has witnessed improved growth in Retail Pharmacy adjusted script comps and year-over-year progress in sales trends in the Specialty Pharmacy business, as the company continues to execute the Fred’s Pharmacy healthcare transformation. The company has announced new board members and closed underperforming stores. Fred’s has been upgrading technical know how, improving supply chain and is focusing on its health care strategy in relation to execution of the Fred’s Pharmacy transformation.

The Rite Aid Transaction

On Dec 20, discount retailer Fred’s entered into an agreement with Rite Aid Corp. (RAD - Free Report) and Walgreens Boots Alliance, Inc. WBA to buy 865 stores located in the Eastern and Western Unites States and certain assets that are required for store operations. The deal is worth $950 million and was paid in cash.

Fred’s Pharmacy is working collaboratively with Walgreens Boots Alliance, Rite Aid and the Federal Trade Commission (“FTC”) to help obtain the FTC’s approval of Walgreen Boots Alliance’s pending acquisition of Rite Aid (announced in Oct 2015) and the divestiture of certain Rite Aid assets to Fred’s Pharmacy. Fred’s Pharmacy announced that it might buy additional assets, including up to 1,200 Rite Aid stores, in order to obtain the FTC’s approval of the transaction. However, the completion of the transaction is still subject to approval by the FTC, and requires other customary regulatory approvals and closing conditions.

The acquisition of these stores will boost company’s network and will position Fred’s Pharmacy as the third-largest drugstore chain in the nation. It will also improve the company’s healthcare growth strategy and would largely benefit its customers, patients, payors, supplier partners, team members and shareholders.

Fred's, Inc. Price, Consensus and EPS Surprise


Fred's, Inc. Price, Consensus and EPS Surprise | Fred's, Inc. Quote

Store Update

As of Apr 28, 2017, Fred’s operates 601 pharmacy and general merchandise stores and three specialty pharmacy-only locations, including 14 franchised Fred’s Pharmacy locations, and 3 specialty pharmacy-only locations.

Looking Ahead

The company’s Retail and Specialty Pharmacy businesses are improving significantly and driving momentum. The company expects the trend to continue throughout 2017. The remodel program in the Front Store is expected to accelerate in the back half of 2017, which will further boost sales.

Fred’s currently carries a Zacks Rank #4 (Sell).

Key Pick from the Sector

Investors interested in the broader retail space may consider Burlington Stores Inc. BURL, which carries a Zacks Rank #2 (Buy) and has long-term earnings growth of 15.85%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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