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Will Fred's Strategic Initiatives Help Lift the Stock?

Zacks Equity Research

Fred’s Inc. FRED posted decent fourth-quarter fiscal 2016 results on the back of strategic initiatives, strong holiday season sales and improving Pharmacy business. In fact, we note that in the past six months, Fred’s shares has been significantly gaining momentum, as the company started to recognize the positive impact of the initiatives it began implementing in 2016. Fred’s shares rallied 21.7% outperforming the Zacks categorized Retail-Discount & Variety industry which gained just 8.7% in the said time frame. Further, we believe there is room for further upside which is also evident from the stock’s VGM score of ‘A’ and long-term earnings growth rate of 8.00%.

Factors to Consider

Fourth-Quarter Results: In April, Fred's posted fourth-quarter fiscal 2016 losses which were narrower than expected. Nevertheless, the company witnessed improvement in bottom line driven by sequential growth in Retail Pharmacy adjusted script comps, sequential progress in sales trends in Specialty Pharmacy business, Front Store margin expansion and strong holiday seasonal category sales. The company expects Pharmacy comp sales growth to persist in 2017.

However, we note that Fred’s traffic trends have remained sluggish over the past few quarters. This is quite evident from the fact that the company’s sales have been declining since the past few quarters owing to a decline in comps. Fourth-quarter sales slipped 4.5% year over year to $529.7 million as comparable store sales dipped 3.6%, compared unfavorably with a gain of 1.7% reported a year ago. Comps declined as a result of the discontinuation of the sale of low productive inventory as against the year-ago period. In fact, in the five-week period ended Apr 1, 2017, a delayed Easter (from March last year to April this year) and a shift in holiday sales into April more than offset the benefit of tax refunds (which were delayed from February to March) led to comps decline.

Though Fred’s witnessed a decline in sales, its gross margins increased 50 basis points (bps) to 24.5%, driven by the successful and profitable sale of discontinued inventory. We note that this gross margin increase was significantly better than the 480 bps decline in gross margins in the preceding quarter, which was due to soft sales and continued reimbursement pressure in the pharmacy category.

Initiatives to Revamp Business: Fred’s is on track to revamp its business. As a result, the company has shifted focused to its pharmacy organization to drive scripts into stores, improve service to patients and provide them with training. The company has also revised its reimbursement strategies that have reversed negative trends and are showing positive results and helping the company to stabilize margins. It has also launched many marketing campaigns that are expected to generate new customers in stores to continue to drive prescription growth.

The Rite Aid transaction: Discount retailer Fred’s entered into an agreement (in Dec 2016) with Rite Aid Corporation RAD and Walgreens Boots Alliance, Inc. WBA to buy 865 stores located in the Eastern and Western Unites States and certain assets. The deal, worth $950 million, was inked to obtain the Federal Trade Commission’s (FTC) approval for Walgreen Boots Alliance’s pending acquisition of Rite Aid (announced in Oct 2015).

Fred’s Pharmacy is working collaboratively with Walgreens Boots Alliance, Rite Aid and FTC and has recently 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 give scale to the company 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 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

Zacks Rank and Key Pick

Fred’s currently carries a Zacks Rank #3 (Hold).

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

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