As I scour the retail scene for values, I sometimes look at companies without much of a following. Though I'm hoping to discover a cream puff, too often all I taste are lemons.
I noticed a post on the Fool's discussion boards asking whether anyone was looking at Fred's
Fred's seemed interesting at first glance. It runs discount stores in small towns, serving up a nice variety of general merchandise, household goods, food staples, and pharmacy. Fred's offers low prices and convenience to a lower-income demographic. Sound familiar? How about Wal-Mart
The company had a nice-looking run going for several years, delivering high-single-digit growth in comparable-store sales, or comps, between 1999 and 2003. During that four-year period, it grew total sales at a compound annual rate of 18%, and earnings per share at 29%. It looked like it had something good going on under the radar.
But in the past five quarters, at least, Fred's has hit a wall. Although it continues to grow the store base by more than 10% per year, earnings have shrunk over those five quarters. Gross margins have more or less held, and comps have slowed to low single digits (which might be expected), but selling, general, and administrative expenses are growing fast enough to obscure sales growth. For a company operating on 2-3% net margins, this can be quite a drag.
In its first-quarter earnings release, management forecast "improved results" for the balance of 2005. But I have a credibility problem with the company. For the past three quarters, it has lowered guidance shortly before the quarter's end. During last year's third quarter, the problem was hurricanes; for the fourth, it was ice storms. In first quarter 2005 there were no weather-related excuses, but a pattern of consistently missing guidance doesn't give me any confidence.
It looks like the analyst community hasn't caught on to this yet. Consensus estimates call for double-digit EPS growth over the balance of 2005. I'll believe it when I see it. In the meantime, with Fred's stock trading at a trailing-12-month P/E ratio above 20, I would steer a wide berth around the company.
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Fool contributor Timothy M.Otte hunts for bargains in Atlanta, where he welcomes comments on his articles. He owns shares of Wal-Mart, but none of the other companies mentioned in this article. The Fool has a disclosure policy.