This Company Is Quietly Growing

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Despite Fred’s (NASDAQ: FRED) having been around since 1947, there’s a pretty good chance you have never heard of it. That is because Fred’s is situated in small to medium-sized towns in the Southeastern United States. Furthermore, it caters to mostly low to middle-income consumers. Unless you are a low to middle-income consumer living in the Southeastern U.S., or unless you are a hardcore investor who studies the market, you are probably not familiar with Fred’s, but you should be.

About Fred’s

Fred’s is a retail discount store and full-service pharmacy that sells everything from household products to pet food to pharmaceutical drugs. Fred’s had been struggling with same-store sales for quite a while, but it is already seeing rewards from a remodeling project. For instance, same-store sales for July increased 2.5%, versus an expectation of 1.5%. General merchandise and pharmaceutical sales both performed equally well.

Fred’s remodeling project focuses on placing the best-performing and highest-margin products in the most visible locations: in its stores. This has the potential to lead to improved top and bottom-line growth. Fred’s is also looking to expand its pharmacy, which should be a wise move considering the aging baby boomer generation. As people age, they need more drugs for various conditions.

Fred’s has seen consistent revenue improvements over the past three years. Fred’s has also been profitable over the past five years. However, earnings per share declined in 2012:

2008: $0.42

2009: $0.60

2010: $0.75

2011: $0.87

2012: $0.81

Overall, the trend has been good. Looking ahead, store remodeling costs could impact earnings in the short term, but the company’s moves are likely to lead to solid top-line growth. If Fred’s performs well, it might eventually expand beyond the Southeast.

Drug stores

Walgreen (NYSE: WAG) is essentially a much larger version of Fred’s, with front-end (consumer products) and back-end (pharmacy) sales. Walgreen owns a market cap around $47 billion, whereas Fred’s sports a market cap of close to $625 million.

Walgreen has been consistent on the top and bottom lines throughout the years, but the company saw a decline in both areas in 2012. A lot of this has had to do with increased competition, as well as CVS stealing some market share. However, it is important not to get too caught up in the Walgreen vs. CVS debate.

They have both been long-term winners, and that is likely to remain the case. Both companies are also well situated for the baby boomer aging trend. Furthermore, both companies are ready for the rapid rise in the popularity of generics, which allow for higher margins than brand name pharmaceutical drugs.

A bigger threat to Walgreen has been discount stores in low-income areas. Walgreen is fighting back with an increase in promotions. This might hurt margins, and earnings, in the near term, but doing nothing was not an option.

Despite weakness in some geographic areas, Walgreen saw overall same-store sales jump 6.7% in July, which was higher than the expectation of 5.3%. Pharmacy sales increased 8.8%, and prescriptions filled improved by 9.5%.

Front-end sales increased 2.3%, but this was weaker than the expected 2.7%. Another negative was a drop of 1.2% in customer traffic. As you might have figured out, basket size made up for the drop in traffic.

Walgreen had some missteps over the past few years, but upper management is wise, and the company should be able to find answers. The brand is strong; the balance sheet is healthy, and industry trends favor the company.

Dollar stores

Dollar General (NYSE: DG) is a different competitor to Fred's as it does not offer a pharmacy. However, it is a market-share-stealing demon.

Dollar General has seen consistent growth on the top and bottom lines annually, and there does not seem to be any hint of a slowdown. Additionally, while we do not know how Dollar General would have fared in 2008 (its IPO was late 2009), we do know that other dollar stores held up extremely well at that time. Therefore, Dollar General is likely to be very resilient to broad market corrections.

What we do know about Dollar General in 2008 is that the economic environment sent many new customers through its doors. At that time, consumers wanted the best value. Dollar General happened to capitalize on this trend by finding ways to retain those consumers through the years.

Dollar General has been so successful that it has even managed to steal market share from Wal-Mart. However, as always, Wal-Mart will fight back.

Wal-Mart plans on opening many smaller stores that mirror dollar store formats. With the Wal-Mart brand name behind it, this has the potential to do some damage to dollar operators.

On the other hand, it could be a complete mishap. Nobody knows how this will play out, but it is a potential threat that should be noted. Despite that threat, Dollar General should continue to grow. Its customers are likely to remain loyal thanks to consistent promotions and savings.

Conclusion

Fred’s has solid growth potential, and management seems to be making all the right moves in order to capitalize on future trends. Walgreen is a more mature play, and it looks to be well situated for future trends. However, it might have trouble competing at the front end of the store due to increased competition. Dollar General might face some increased threats from Wal-Mart in the near future, but until that threat turns into market share losses, Dollar General should remain a quality investment.

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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