Fred’s Inc. (FRED) posted an EPS of 22 cents in its fourth quarter of fiscal 2010, which missed the Zacks Consensus Estimate by 1 cent. However, it was 49% higher than the earnings reported in the year-ago quarter. For full year 2010 earnings increased 25% year over year and were reported at 75 cents, in line with the Zacks Consensus Estimate.
Total sales increased 3% year-over-year to $485.6 million, missing the Zacks Consensus Estimate of $487.0 million. Fred’s total sales for 2010 increased 3% to $1.842 billion from $1.788 billion for the same period last year.
The revenue growth also matched the company’s guided range of 3% to 4% of sales growth. Comparable store sales for the quarter increased 2.3% compared with the decline of 0.9% for the fourth quarter last year. For full year 2010, comparable store sales for 2010 increased 2.2% on top of an increase of 0.4% in 2009.
On a monthly basis, comparable store sales increased 0.2%, 2.1% and 0.9% in December, January and February, respectively. Comparable store sales, in all the three months, were boosted by increased traffic, improved sales mix, solid comparable script growth in the pharmacy department and strong Core 5 department results.
In December, the company’s strategy to drive profitability with lower promotional advertising and reduced markdowns for the month resulted in a modest sales improvement. January comparable store sales particularly did not produce the desired results due to poor weather and the inability of customers to get early tax refunds in January.
February saw low sales in the beginning owing to harsh weather. However as the month progressed, factors like improved weather conditions along with customers beginning to receive tax refunds led to enhanced customer traffic and higher sales at the stores.
Cost and Margin Performance
Expenses increased in the quarter with cost of goods sold edging up 1.4% to $351.2 million. Selling, general and administrative expenses 26.1% of sales compared with 25.8% in 2009. Positive factors like leverage in store occupancy costs, professional fees and distribution expenses were offset by higher store and pharmacy labor, incentive compensation, and fuel expenses. For 2010, selling, general and administrative expenses were 26.1% of sales compared with 25.8% in 2009.
Gross profit grew 6% to $134.4 million with gross margin up 90 basis points to 27.7%, benefiting from controlled markdowns and shrinkage, as well as improved pharmacy department margin performance.
Operating income increased 52% to $13.7 million. Operating margin improved 90 basis points from the year ago period to 2.8%. For the full year, operating income posted a decent 21% year-over-year growth to $46.7 million. Operating margin increased 50 basis points to 2.5% in 2010.
Financial Position
As of January 29, 2011, Fred’s had cash and cash equivalents of $49.2 million, down from $54.7 million as of January 30, 2010. As of January 29, 2011, the debt-to-capitalization ratio was at 0.9% from 1% as of January 30, 2010.
During 2010, Fred’s opened 15 store and 21 pharmacy locations and closed 7 store and 15 pharmacy locations. The company also refreshed 196 stores with its new Core 5 elements.
Outlook
Management expects tough retail conditions to continue across the markets in 2011 due to ongoing concerns about rising petroleum prices and their macroeconomic effects. However, it feels that the company is well-leveraged to capitalize on these accomplishments made last year. The efforts made in 2010 coupled with new 2011 programs, will ensure higher traffic in the stores, while continuing to drive strong financial returns.
The company expects earnings per diluted share to increase 14% to 24% to a range of 24 cents to 26 cents for the first quarter compared with earnings per share of 21 cents in the same period last year. In the first quarter of 2011, management expects total sales to increase 2% to 4%.
Comparable store sales are expected to increase 1% to 3% versus an increase of 2.2% in the first quarter last year. Based on this outlook, the company expects total earnings per diluted share for 2011 to be in the range of 84 cents to 90 cents, representing an increase of 12% to 20% over last year.
Fred’s, based in Memphis, Tennessee, operates discount general merchandise stores mainly in southeastern U.S. It offers nationally recognized brands, and private label and lower-priced, off-brand products.
The company’s merchandise mix includes more than 12,000 frequently purchased items, consisting of household goods, apparel, food, tobacco, healthcare and paper products. Some of its retail outlets also feature pharmacies, which offer prescription drugs.
Fred’s faces stiff competition from Dollar General Corporation (DG) and Walgreen Co. (WAG). It 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.
DOLLAR GENERAL (DG): Free Stock Analysis Report
FREDS INC (FRED): Free Stock Analysis Report
WALGREEN CO (WAG): Free Stock Analysis Report
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