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Why Is Fred's (FRED) Down 12.6% Since the Last Earnings Report?

Zacks Equity Research

About a month has gone by since the last earnings report for Fred's, Inc. FRED. Shares were down 12.6% in that time frame, underperforming the market.

Will the recent negative trend continue leading up to the stock's next earnings release, or is the stock due for a breakout? Before we dive into how investors and analysts have reacted of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important catalysts.

Fred's Q2 Loss Narrower Than Expected, Sales in Line

Fred's Pharmacy posted narrower-than-expected loss in second-quarter fiscal 2017. Sales were also in line with the Zacks Consensus Estimate. Notably, the quarter witnessed the bottom-line improvement in comparison with the prior-year period for the first time over a year. We believe the turnaround initiatives have aided the company to report moderate decline in comparable-store sales (comps).
 
Q2 Highlights

The discount retailer witnessed adjusted quarterly loss of 15 cents per share, which was narrower than both the Zacks Consensus Estimate loss and prior-year loss of 18 cents. This was on the back of comps improvement and expansion in gross margins.

Including non-recurring and asset impairment costs, quarterly loss came in at 78 cents per share.

Quarterly net sales declined 4.1% year over year to $507.8 million but were almost in line with the Zacks Consensus Estimate of $507 million. The downturn was mainly due to the closure of 39 underperforming outlets in the previous quarter.

Comps slipped 0.3% in the quarter, hurt by the persistent rise in generic dispensing rate, coupled with a 0.8% effect from the sale of low productive discontinued inventory in comparison with the year-ago period. However, the decline was narrower than a 2% dip witnessed in the year-ago period. Excluding the discontinued inventory effect, total comps represented positive growth in the quarter.  

While the company’s gross profit dropped 1.7% year over year to $126 million in the quarter, gross margin expanded 60 basis points to 24.8%. The uptick was driven by gains from its turnaround plan. However, Fred’s adjusted operating loss came in at $28.1 million in the quarter, wider than the year-ago period’s loss of $10.9 million.

Meanwhile, the company continues to witness improvement in Retail Pharmacy, delivering flat comp script on a year-to-date basis. Also, growth has been seen in its generic dispensing rate along with gross profit dollar per script on the whole.

Also, in its Specialty Pharmacy business, management successfully delivered momentum driven by turnaround strategies, solid sales growth backed by geographic expansion and diversification with the existing therapies.

Markedly, the company has installed a new operating system in the Memphis specialty facility, which is likely to be completed by November.  This implementation will aid the company to maintain its retail and specialty businesses with the same operating system. Going forward, it is likely to provide a single view of the patients, facilitating the treatments and therapies in both businesses.

In the Front Store operations, management witnessed improvement in the key edibles categories in comparison with the last year, in spite of food deflation in consumables as well as continuing market headwinds.

Financial Update

Fred’s ended the fiscal second quarter with cash and cash equivalents of $5.7 million, long-term portion of indebtedness of $138.7 million and shareholders' equity of $270.7 million.

Store Update

As of Jul 29, 2017, Fred’s operates 600 pharmacy and general merchandise stores. This includes 14 franchised Fred’s Pharmacy locations along with three additional specialty pharmacy-only locations.

Looking Ahead

We note that Fred’s remains committed to the successful execution of its turnaround strategy, which is likely to mainly focus on reducing selling, general  and administrative (SG&A) expenses and driving free cash flow and overall profitability.

Additionally, the company is prioritizing the areas with a competitive gain and those where improvement is required. In fact, the company has made leadership changes and is committed to enhance its shareholders’ value as well.

Furthermore, its Retail and Specialty Pharmacy businesses are improving significantly, and the momentum is likely to continue throughout fiscal 2017.

How Have Estimates Been Moving Since Then?

Analysts were quiet during the last month as none of them issued any earnings estimate revisions.

Fred's, Inc. Price and Consensus

 

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

VGM Scores

At this time, Fred's stock has an average Growth Score of C, a grade with the same score on the momentum front. The stock was allocated a grade of F on the value side, putting it in the bottom 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of D. If you aren't focused on one strategy, this score is the one you should be interested in.

The company's stock is suitable for growth and momentum investors based on our styles scores.

Outlook

The stock has a Zacks Rank #4 (Sell). We expect below average returns from the stock in the next few months.


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