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28 Aug

Fred’s Turnaround Is In The Cards

by

FRED is a good example of a play on the ability of management to ‘turnaround’ the company’s flagging profitability.   In a shrinking brick-and-mortar retail environment in the United States, Fred’s is undergoing an aggressive rightsizing of its business.  

As many of my loyal subscribers know, I’ve done well in the past with select turnaround plays, because the strategy of buying stocks at very depressed prices typically result in two-bag-plus returns when I pick the right play.  I believe FRED is one of those stocks.

I became interested in FRED following its Jun. 29 announcement of the termination of a deal between Walgreens and Rite Aid, disallowing Fred’s the opportunity to acquire up to 1,2000 Rite Aid stores.

FRED immediately plunged to $9.51 from the Jun. 28 closing price of $12.31, a 22.8% crash within one trading day.  The stock continued to decline over the course of eight trading days until the stock reached a low of $6.17 on Jul. 12., a 50% cut to Fred’s capitalization.  The stock has since formed a base and trends upward.

After watching FRED stabilize, on Jul. 17, I alerted my purchase of 5,000 shares of FRED at $6.57 per share.

Overall, Fred’s has issued reliable earnings forecasts during its turnaround phase.  The initiatives taken by management during the past 18 months of the company’s turnaround include beefed up management staff with experienced retail turnaround specialists, added information technologies at its pharmacies, remodeled 44 stores, and implemented a market intelligence network capable of identifying merchandise trends in the marketplace in order to assess stocking, promotion and inventory needs at its 601 stores.   

Those of my subscribers interesting in taking a position in the stock along with me should realize that the above-mentioned initiatives won’t show results until the second half of the year, but will be included in the coming earnings report scheduled for next week, Sept. 6 (before the market opens).  At that report scheduled for early-December, I’ll be looking at revenue and gross margin very closely, as Fred’s CEO Mike Bloom issued guidance that profitability is expected by year-end.

Fred’s CEO, Mike Bloom closed his conference call remarks on June 6:

We anticipate continued operational improvement throughout 2017 as the initiatives underway continue to deliver results. And as a result of our initiatives, we expect to be profitable on an operational basis by the end of fiscal 2017.

Fred’s has focused its attention toward its retail and specialty pharmacy business, where the company has so far demonstrated a 3.3% jump in same-store sales in the case of the former, and a 24% y-o-y spike to sales, in the case of the latter.  

In addition, management has said that in Q2 it saw a 1% y-o-y increase to generic drug sales, a result of which has been due to aggressive work enlisting local hospitals to refer patients to Fred’s 340B program, which is now offered in 70 Fred’s locations.  The company plans to double this store count by the end of calendar year 2017.

As of Friday, FRED trades at a price-to-sales of 0.11.  When compared to the industry average of 0.51, the market for FRED is offered at a 21.5-cents-on-the-dollar investment to play this turnaround story.  If management succeeds with its turnaround, as I expect it will, the upside to the stock might end up a two-bag or three-bag play.

Fred’s debt-to-equity of 0.52 is quite low for a stock trading at such a depressed price.  In other words, Fred’s is not ‘on the ropes’ to bankruptcy as many retailers in Fred’s position are, which is a testament to management’s conservative use of its balance sheet prior to entering a difficult US retail environment and the present turnaround phase at the company.

Management expects gross margin to rise in the coming quarters, beginning in Q3 2017, which won’t be reported until early-December.  So, my bet on FRED may not show meaningful results until then.

However, as a short-term play, Fred’s announced on Aug. 18 a cash dividend of $0.06 per share to stockholders of record on Sept. 1, the dividend of which will be paid on Sept. 15.  In the past, the stock has rallied into the ex-dividend date, which, in this case, is Sept. 1.  If any of my subscribers want to play the ex-dividend play for a quick single-digit gain for holding the stock a couple of days, the opportunity is this week.

For those seeking a longer-term play in the hated retail sectors, hate sometimes turns to love when a retailer pulls off a successful turnaround.  By December, I expect FRED to be loved.

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1 Comment

  1. Rich Kranz

    Well reasoned and thoughtful article JB! Where can I find these type of articles on jasonbondpicks.com? Is there an archive or something? I would like to read any beginner trading articles as the one I read the other day really stuck!
    Thanks,
    Rich

    Reply

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