Earnings Preview: Fred’s Inc.

Fred’s Inc. (FRED) is scheduled to report its fourth-quarter and full year 2010 financial results on March 24, 2011. Currently, for the fourth quarter, the Zacks Consensus Estimates are 21 cents per share in earnings and $487 million in revenue. For full year 2010, earnings are expected to be 75 cents per share on revenue of $1,843 million.

Third-Quarter 2010, a Synopsis

Fred’s Inc., which faces stiff competition from Dollar General Corporation (DG) and Walgreen Co. (WAG), reported better-than-expected third-quarter 2011 results and posted robust pro forma earnings of 20 cents per share, beating the Zacks Consensus Estimate by 11.1%. Net income was $7.8 million, which was up by 55% from the year-ago period.

The improvement in earnings reflected ongoing initiatives taken by management to drive customer traffic and margin expansion, with an emphasis on Core 5 program, focused on upgraded merchandise assortment.

During the quarter, total sales shot up by 3% to $435.0 million from $422.4 million in the prior-year period. The improvement was primarily attributable to solid merchandising and marketing plans. Comparable store sales for the quarter increased 1.5% compared with an increase of 1.0% in the third quarter last year.

Fred’s gross profit for the third quarter of 2010 climbed 6% to $129.7 million from $122.9 million a year ago. Gross margin for the quarter increased 70 basis points to 29.8% compared with 29.1% in the same quarter last year. The improvement in gross margin for the quarter was driven by restricted general merchandise markdowns and shrinkage, as well as superior pharmacy department margin performance.

Management Guided

At its last earnings conference call, the company said that it expects total sales to increase 3% to 4% in fourth quarter 2010. Comparable store sales are expected to increase 2% to 4%. Earnings per diluted share are forecast to increase by 33% to 60% to a range of 20 cents to 24 cents for the fourth quarter. The company expects total earnings per diluted share for fiscal 2010 to be in the range of 74 cents to 78 cents, representing an increase of 25% to 32% over last year.

Fourth-Quarter 2010 Zacks Consensus

Analysts covered by Zacks expect Fred’s to post fourth-quarter 2010 earnings of 21 cents a share. The current Zacks Consensus Estimate represents a year-over-year growth of 40% and ranges from a low of 20 cents to a high of 22 cents.

The current estimate remained stagnant over the last 30 days as none of the analysts revised their estimates upward. The current estimate decreased by 2 cents from the estimate prevailing 90 days ago.

Mixed Earnings Surprise History

With respect to earnings surprises, Fred’s has outpaced the Zacks Consensus Estimate by an average 10.8% over the last four quarters, ranging from 0% to positive 11.1%.

Our Recommendation

Fred’s has carved a unique niche for itself in the discount retail market by offering a wide array of merchandise and frequently purchased household items, specifically targeted at low and middle income households in small and medium towns. This provides the company a competitive edge over its larger peers, who lack a significant presence in these areas. The company has a healthy debt-free balance sheet, which will support top-line expansion in the future.

However, the company sources a significant portion of its merchandise from foreign suppliers, primarily located in the Far East. Accordingly, the company is vulnerable to political, social and economic risks associated with operations in these countries. Again, the highly fragmented industry faces intense competition from national, regional and local retailing establishments, including department stores, discount stores, discount clothing, grocery and convenience stores and drug stores.

Fred’s currently holds a Zacks #3 Rank. On a long-term basis, we maintain a Neutral rating on the stock, with a short-term Hold rating.

FREDS INC (FRED): Free Stock Analysis Report

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