Bleak News From Fred's

Discount retailer Fred's (Nasdaq: FRED  ) was relieved that it was able to meet its lowered forecasts for the fourth quarter. Set the bar low enough and you can merely step over it instead of having to hurdle it. 

Overhead headaches
As the economy contracts, so does Fred's. It has come under pressure as customers' discretionary spending is squeezed by higher fuel and food costs. As a result, the discounter, which probably more closely resembles a Big Lots (NYSE: BIG  ) model than those of Dollar Tree (Nasdaq: DLTR  ) or 99 Cents Only (NYSE: NDN  ) , announced it was closing 75 stores as it tries to rein in overhead expenses.

Compared with the fourth-quarter profit of $9.2 million the company posted last year, Fred's reported a loss of $4.4 million. Sales slid 8%, though last year's results were helped by an extra week. But even factoring out the 14th week left revenue down 2% from last year.

Fred's has been under margin pressure as well, with gross margins sliding 260 basis points to 23.6% because of inventory liquidations from the store closings, lower markups, and a poor mix of merchandise.

A prescription for health
It could have been worse. The one bright spot for the company has been its pharmacies, which have stronger margins. Fred's sets itself apart from its competition by offering customers a place where they can buy their discounted prescriptions. By focusing on generic brands, it's able to make extra profits even though those brands carry lower selling prices.

Wal-Mart's (NYSE: WMT  ) pharmacies are like the 800-pound gorilla in the corner, but Fred's pharmacies represent the key differentiator and could be the way to build up margins by increasing traffic in the stores. It could be the pharmacies that attract a buyer for the company, should it decide to sell itself.

Back in November, Fred's said it had received inquiries about being acquired. Fred's appointed Merrill Lynch (NYSE: MER  ) to research its "strategic alternatives," and the latest earnings report suggests that the best alternative may be to find a buyer.

Find more about Fred's here:

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