Fred’s Swings to Loss on Store Closures and Inventory Charges

Retail chain feels the sting of food deflation and pharmacy reimbursement pressure

a1Discount retail chain Fred’s Inc. (NASDAQ: FRED) announced its Q3 FY16 financial results on December 08th, 2016.

The Memphis, Tennessee-based Company, together with its subsidiaries, sells general merchandise through its retail discount stores and full service pharmacies. It offers household cleaning supplies, health and beauty aids, disposable diapers, pet foods, paper products, various food and beverage products, and pharmaceuticals to low, middle, and fixed income families in small- to medium-sized towns. It also sells general merchandise to franchised Fred’s stores. Read more about Fred’s financial results below.

Q3 FY16 financial highlights

During Q3 FY16, Fred’s total sales declined 4.5% to $516.6 million compared to $541.0 million in the year-ago same period. Comparable store sales fell 3.8% versus an increase of 2.7% in the year-ago comparable period.

Separately, Fred’s also reported sales for the four weeks ended November 26th, 2016, which again presented a dismal picture. Sales again fell 3.6% to $159.7 million from $165.7 million in November 2015. Moreover, comparable store sales for November 2016 declined 2.9% versus an increase of 1.7% in November 2015.

a2During Q3 FY16, Fred’s gross profit fell to $111.2 million from $142.3 million in the prior year’s comparable period, mainly due to inventory impairment charges, pharmacy reimbursement pressures, and the decline in Y-o-Y sales. Gross margin for Q3 FY16 fell 480 basis points to 21.5% from 26.3% in Q3 FY15.

Fred’s recorded last in first out (LIFO) adjustments of $2.1 million in Q3 FY16 compared to $0.03 million in the same quarter last year. Moreover, Fred’s selling, general, and administrative (SG&A) expenses, including depreciation and amortization, jumped 410 basis points to 30.0% of sales from 25.9% of sales in Q3 FY15. The deleveraging in expenses in Q3 FY16 was primarily caused by a decrease in sales volume combined with fixed asset impairment charges and consulting fees resulting from the Company’s initiatives.

As a result, during Q3 FY16, Fred’s reported an operating loss of $44.1 million, or (8.5%) of sales, compared to an operating income of $2.4 million, or 0.4% of sales, in the prior year’s same period. EBITDA turned negative to a loss of $32.1 million, or (6.2%) of sales, compared to EBITDA of $13.8 million, or 2.5% of sales, in the year earlier comparable quarter.

Consequently, Fred’s swung to a net loss of $38.4 million, or $(1.05) per share, in Q3 FY16 compared to a net income of $1.4 million, or $0.04 per share, for the year ago same period. The Company recorded charges totaling $38.0 million, or $0.78 per share, after tax during the quarter, primarily related to inventory write-downs and the closure of 40 stores scheduled to occur in the first half of 2017.

Source: Company's Data
Source: Company’s Data

Other highlights

Store update: As of the end of Q3 FY16, Fred’s operated 647 discount general merchandise stores and three specialty pharmacy-only locations in 15 states in the southeastern US. Included in the store count are 18 franchised locations. Also, there are 370 full service pharmacy departments located within Fred’s stores, including four franchised locations. The company plans to close 40 stores in H1 FY17.

Cash position: As of the end of Q3 FY16, Fred’s had cash and cash equivalents of $5.69 million versus $6.64 million in the same period a year ago.

Inventory: As of the end of Q3 FY16, Fred’s inventories declined to $366.5 million versus $369.9 million in the year-ago comparable period.

Dividend: Fred’s announced a quarterly dividend of $0.06 per share, which will be paid on December 15th, 2016, to shareholders on record as of December 01st, 2016.

Guidance for H2 FY16

Given that Fred’s faces headwinds in the form of declining food prices, lower store traffic, and lower average ticket, management is focused on positioning Fred’s as a leading healthcare-focused company. The company also faces intense competition from big box retailers such as Wal-Mart Stores Inc. (NYSE: WMT), The Kroger Co. (NYSE: KR), and Whole Foods Market Inc. (NASDAQ: WFM), among others, which offer a greater variety of products and services.

Based on recent sales trends and near-term outlook, Fred’s expect changes in both total sales and comparable store sales to range from negative 1% to a positive 1% during H2 FY16. Fred’s also predicts a loss per diluted share to range between $(0.18) to $(0.23). Adjusted EBITDA is expected to be in the range of $18 million to $21 million during H2 FY16.

Stock Performance

a4nFred’s stock ended the day at $10.85, slightly up 0.09%, at the close on Friday, December 09th, 2016, having vacillated between an intraday high of $11.03 and a low of $9.61 during the session. The stock’s trading volume was at 1,096,298 for the day. The Company’s market cap was at $404.92 million as of Friday’s close.

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