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Why Fred's Couldn't Make It as a Discount Retailer

By Rich Duprey – Sep 18, 2019 at 9:31AM

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Despite a booming sector, it had bigger dreams as a pharmacy giant.

Discount retailer Fred's (FRED) always seemed out of place, being neither fish nor fowl. Its deep-discount retail model with a pharmacy business thrown in on the side set it apart from the likes of dollar stores such as Dollar General (DG -1.09%) and pharmacy businesses like CVS Health (CVS -0.54%).

Fred's was arguably more like a small Walmart, and yet despite the strong performance of the discount retail sector, it always seemed to struggle every year. That battle just culminated in the chain declaring bankruptcy last week and Fred's saying it will liquidate its roughly 300 stores over the next two months, bringing to an end its 72-year history.

So in a market where discount chains thrive, let alone survive, why did Fred's have to fold its hand?

Store going out of business

Image source: Getty Images.

Dreams of being a heavyweight contender

The seeds for its eventual demise seem rooted in its conviction that its pharmacy business was the key difference between it and other discount chains, since its stores with pharmacies outperformed those that didn't have one.

For that reason, it continuously added pharmacies. But in 2015, it narrowed its focus to concentrate on specialty pharma, which it said was the largest growth segment of the industry. It provided clinical and administrative services to patients who need high-cost drugs to treat chronic or rare conditions such as hepatitis, cancer, and multiple sclerosis. 

When Walgreens Boots Alliance (WBA -0.80%) and Rite-Aid (RAD 0.92%) sought a $9 billion merger in 2016, Fred's saw an opportunity to vastly expand its reach to help the two meet antitrust concerns. It agreed to buy 865 Rite-Aid stores for $950 million in cash, a move that would have converted it from being a small regional player to one of the biggest national chains.

Whether that would have actually helped the long-struggling discounter is unknown, because the Federal Trade Commission quashed the merger and Walgreens cut Fred's out of the deal, buying almost 2,200 Rite-Aid stores for itself.

Spiraling down quickly

Fred's was already losing money, though, and up until its bankruptcy filing hadn't turned a profit since 2015. At its peak in 2012, it operated 691 discount retail stores with 346 pharmacies inside, and another 21 stores were franchisee-owned. But after the failed Rite-Aid deal, Fred's couldn't get out of the pharmacy business fast enough, going from 348 pharmacies at the end of 2017 to 169 at the end of last year, and it sold off its specialty pharma business for $40 million.

As its financial situation deteriorated more, it began rapidly closing stores. By the end of June it had shut down and liquidated the inventory of over 260 locations, leaving it with fewer than 300 stores. On Sept. 9, Fred's declared bankruptcy.

CEO Joe Anto, who took over from Michael Bloom -- who left after the failed Rite-Aid deal -- said in a release announcing the dissolution of the company, "Despite our team's best efforts, we were not able to avoid this outcome." It plans to keep filling prescriptions at its pharmacy until it can find a buyer for the business.

Stay within your circle of competence

Fred's seems to be a cautionary tale of trying to punch above its weight class. While the retailer had struggled for years, the attempt to go from a regional healthcare player to a national one did it in. It failed to get the basics of its discount retail operation on a sound footing as it tried to break into the pharmacy big leagues.

Where shares of deep discounters like Dollar General have more than doubled over the last three years, pharmacy chains CVS and Walgreens have lost 20% or more of their value, suggesting Fred's backed the wrong horse. Doing one thing and doing it well may have served the deep discounter better than pursuing a grandiose plan to become a national pharmacy chain.

 

Rich Duprey has no position in any of the stocks mentioned. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Fred's, Inc. Stock Quote
Fred's, Inc.
FRED
Walgreens Boots Alliance, Inc. Stock Quote
Walgreens Boots Alliance, Inc.
WBA
$32.43 (-0.80%) $0.26
CVS Health Corporation Stock Quote
CVS Health Corporation
CVS
$97.21 (-0.54%) $0.53
Rite Aid Corporation Stock Quote
Rite Aid Corporation
RAD
$6.56 (0.92%) $0.06
Dollar General Corporation Stock Quote
Dollar General Corporation
DG
$235.85 (-1.09%) $-2.61

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