Fred's, Inc. (FRED) Q1 Earnings Beat, Sales Lag Estimates

Fred's, Inc.’s FRED shares rallied almost 5.15% in response to the higher-than-expected earnings for the first quarter of fiscal 2016. Although sales met estimates, lower comps dampened investors’ confidence.

Fred's’ first-quarter earnings of 3 cents beat the Zacks Consensus Estimate of 2 cents by 50.0%. The results improved substantially from the breakeven reported a year ago, mainly on the back of higher revenues. First-quarter earnings include expenses related to prior periods of $0.4 million or 1 cent per share.

 

FREDS INC Price and EPS Surprise

FREDS INC Price and EPS Surprise | FREDS INC Quote

Revenues & Margins

First-quarter sales increased 8% year over year to $549.55 million from $509.0 million but came in below the Zacks Consensus Estimate of $552 million by 0.4%. The year-over-year rise in sales was driven by synergies from the Apr 2015 acquisition of EntrustRx specialty pharmacy.

Comparable store sales increased 1%, higher than the 0.8% improvement recorded last quarter. Results were also better than 0.8% comps reported a year ago driven by the general merchandising gain of 0.8% and the pharmacy department increase of 1.3%.

While traffic was down 1.8%, customer ticket was up 2.8% driven by a larger front store basket and an increase in average script price. Categories like Household goods and softlines, pharmaceuticals improved from last-year levels while consumables and franchise sales showed deterioration.

Gross profits increased 3.1% year over year to $141.3 million. Gross margins contracted 120 basis points (bps) to 25.7% of sales from the prior-year period mainly due to a sales mix shift toward lower-margin specialty drugs, wider margins in general merchandise departments and continued reimbursement pressure.

Selling, general and administrative expenses shrank 160 bps to 25.3% of sales due to lower occupancy costs, controlled labor costs and reduced expenses related to the growth of specialty pharmacy.

Fred's reported an adjusted operating income of $2.4 million compared with $0.75 million a year ago.  Operating margin inflated 30 bps to 0.4% due to lower selling general and administrative expenses.

During the first quarter, the company opened one full-service store. At the end of the quarter, there were 660 discount general merchandise stores and three specialty pharmacy-only locations across 15 states in the southeastern United States.

Fiscal Second-Quarter Outlook

The company had a soft start to the second quarter of fiscal 2016. The company expects comparable store sales in May to range from slightly negative to flat. Sales are expected to be impacted by the shift in Memorial Day year over year.

For the second quarter, comparable store sales are expected to remain flat or increase up to 2%. Total sales are projected to range from flat to an increase of 2%. Earnings per share are projected in the range of flat to 3 cents compared with nearly flat results in the prior-year quarter.

Fiscal 2016 Guidance

For fiscal 2016, Fred’s expects total sales to increase 2% to 6% compared to a range of 5% to 9% expected previously. Comparable store sales are likely to increase in the range of 1% to 4% compared to 2% to 5% projected previously. The company reported a 1.5% rise in fiscal 2015. The lower sales guidance reflects industry-wide slowdown in the hepatitis C specialty drug market.

The earnings per share guidance was maintained in the range of 27 cents to 32 cents compared with 9 cents reported last year.

This Zacks Rank #3 (Hold) company seems to be making a comeback after witnessing sluggish comps and intense competition in the discount retail sector over the past few quarters. Sales and profit initiatives are yielding significant results as is evident from the improvement in fiscal first-quarter comps. However, declining margins remain a concern.

Stocks to Consider

Some better-ranked stocks in the same sector are The Michaels Companies, Inc. MIK, Wal-Mart Stores Inc. WMT and The Kroger Company KR. All three stocks carry a Zacks Rank #2 (Buy).

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