Does Fred Have What it Takes?

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Freds Super Dollar (NASDAQ: FRED) is a discount store offering household products, foods and beverages, paper products, health and beauty needs, tobacco, cleaning supplies, apparel, pet products, and just about everything else. Fred's also operates pharmacies in a large percentage of their stores. This company is focused on providing goods to low, middle, and fixed income families in small to mid-size towns. Fred's states that their mission is to be "the hometown discount store that provides a fast, fun and friendly low-price place to shop!" Fred's may also be a fast and fun way to make profits.

The Stores

Fred's currently operates 700 stores in the southeastern United States, including 320 that double as pharmacies. Fred's carries brand name products such as Procter & Gamble, Kimberly Clark, and Coca Cola, but mainly focus on selling their own Fred's brand for $1. Their brand makes generic versions of people's favorite foods, along with a full line of baking products, cleaning products, personal care products, and more. These products go through thorough testing and have actually won awards against leading national brands. 

A huge upside for Fred's is that they own and operate pharmacies. Fred's Pharmacy accepts most all insurance plans, including Express Scripts, Humana, Cigna, TRICARE, Blue Cross, CVS Caremark, and Medicare. They can fill all of your prescription needs online through their website or on your mobile device using their app. Fred's Pharmacy also offers generic drugs for just $4. They have a Fred's line of products for allergies, cold and flu, vitamins, headache relief, ibuprofen, and over 50 others. $4 is an incredible deal compared to what you will pay for Johnson & Johnson products. 

In January, Fred's announced they would be expanding pharmacy operations by adding clinical services. This would be like the Minute Clinic at CVS. They are also looking to acquire pharmacies in their current store areas to increase their presence. This will be a great addition to Fred's model.

While you are taking care of your own health at Fred's, you can take care of your best friend while you're at it. Fred's carries all of the pet care products you need. They carry everything from shampoo and dental care products to flea, heartworm, arthritis, and cancer medications. This means Fred's is like Dollar General, CVS, and PetSmart combined. 

Franchising

Fred's has made an incredible move by adding franchises. They currently have 21 franchised stores in 15 states, and this number could continue to grow. There is no information listed on their website, as most franchises do, but this should change eventually. If Fred's is to add as many franchised stores as corporate-owned stores, they could double their profit on fees and royalties alone. Fred's needs to go all-in on this idea.

The SmartCard

Loyalty programs are very important for retailers to ensure return customers. Fred's loyalty program is a point system in which customers receive a SmartCard. This SmartCard collects points on all purchases made in the store and earns the customer SmartBucks. The SmartBucks can be spent like cash on anything in the store or pharmacy. This is just like what you will find at CVS, which is one of the most successful loyalty programs in the United States. Dollar General, Family Dollar, and Dollar Tree do not have loyalty programs, giving Fred's an edge.

Expansion

Fred's is currently in the process of expanding. On top of expanding, they are giving their stores a new look. These stores have new layouts, better lighting, more shelving, wider aisles, and increased signage. Also, Fred's has expanded their food selections to double what traditional Fred's stores carry. All of this together gives the stores a higher quality feel and makes for a happier shopping experience.

Three of the most notable newly added stores are in Memphis, Tennessee and Foley, Alabama. Fred's is headquartered in Memphis, so by adding two more stores they will increase their market share in the area and continue to grow their numbers. Both stores have pharmacies as well. Memphis is the largest city in Tennessee and the third largest in the southeast with a population of over 650,000. This gives Fred's plenty of potential customers. 

Foley, Alabama is not a well known city and has a population of around 15,000 people, but this is exactly where Fred's wants to be. Fred's is a small to mid-size town store and Foley is a small to mid-size town. Fred's will instantly become the go-to place for this city. The new store is 16,000 square feet with a pharmacy and drive through. Continuing to expand into these small towns will increase their brand awareness and allow them to expand to the surrounding areas. Expansion will be key for Fred's continued success.

Competition

A main competitor to Fred's is Dollar General (NYSE: DG). Dollar General has stores scattered in the same area as Fred's, but their growth is more focused in the West. They currently operate over 10,000 stores, making them a force in the industry. Dollar General seems to always have the next big thing going on. They were the first dollar store to add refrigerated sections and expand into full blown "marketplaces." Dollar General also has its own brand of products called Clover Valley and carries the brand name products that Fred's does. 

As mentioned before, Dollar General is focused on expanding west. They have a huge presence in the east and want to make that the same case across the nation. This could double their overall size and will greatly benefit the economy by adding thousands of jobs. This is also a positive for Fred's, because they are focusing on expanding in the areas that Dollar General is ignoring for now.

Dollar General has its downsides though. Unlike Fred's, they do not have pharmacies or loyalty programs and are not adding clinical services. Dollar General is top dog in this space, but Fred's is well positioned to increase its share in the southeast. 

A competitor who has a lot in common with Fred's is CVS Caremark Corporation (NYSE: CVS). As mentioned before, CVS has a strong loyalty program, pharmacies, and sells the same lines of products as Fred's. CVS and Fred's are like mirror images of each other.

CVS has their own generic line of products at a discount to the brand names. However, you will not find them for just $1 and will not find generic over-the-counters for just $4 like you will at Fred's. CVS has all the pieces to continue growing, but this is a healthy competition. Though CVS is much larger, they are not large enough to where if a CVS opened up across the street from a Fred's that they would immediately put Fred's out of business. A competition like this is much like McDonald's and Wendy's. They can be right next door to each other, but each will still serve millions of customers each year. 

The Dividend

A positive for Fred's stock is their 1.80% dividend, which they have paid since 1993. Since 2008, Fred's has increased their quarterly dividend by $0.01. In 2012, they paid $0.06 quarterly, so it is safe to assume it will increase to $0.07 quarterly in 2013. With an annual dividend of $0.28, Fred's yield would rise to 2.1%. This is not the largest dividend you will find, but it does show they are determined to return value to shareholders.

January, 4th Quarter, and Fiscal 2012 Numbers

Fred's reported January sales of $173.6 million, up 31% from December and 2% year-over-year. Comparable store sales increased 28.6%. This is positive news as of late, so if Fred's can keep this up they are in for a huge year.

Fourth quarter 2012 sales rose to $533.5 million. This is up 7% from $497.7 million in 2011. In this quarter, comparable store sales increased 4.8%. 

Fred's had a record year in 2012. Total sales rose to $1.956 billion, a 4% increase from 2011. However, comparable store sales increased just 1.1% on an adjusted basis. Setting their own record for sales was impressive, but the 4% year over year increase and 1.1% increase in comparable store sales were not impressive at all. 2013 and 2014 looks to be much brighter for Fred's

Current Share Price

Fred’s is currently trading at $13.34, which is 16.5% below its 52 week high of $15.98. At current earnings of $0.89 per share, Fred's is trading at a 14.98 multiple. They have a very respectable market cap of $490 million. Their current beta is 0.9, meaning they are less volatile than the overall market.

2013 & 2014 Projections

In 2013, Fred's is projected to earn $1.01 per share, a 13.5% increase from 2012. This is not as large of a growth as I would like to see from a company with a market cap under $500 million, but looking two years out makes the valuation worth it.

In 2014, analysts expect Fred's to earn $1.16 per share. This would be a 14.8% increase from 2013 and 30.3% from 2012. If Fred's were to continue trading at a multiple of 15, this would put them around $17.50 per share. This represents a 32% move from its current level. I will take a 32% gain in two years any day of the week. Below is a chart of this expected earnings growth.

 

Expectations

2013 has the potential to be a solid year for Fred’s. I believe they can return to the $15 range by the end of the year, and with the growth in earnings and the continued dividend increases, I think Fred's can easily run up to $18 per share. This would be an incredible 35% move in two years, but Fred's is strong enough to pull it off. I am initiating an outperform call on CAPS. Fred's Super Dollar is a long term BUY.


JoeySolitro1 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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