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FRED - New Business Drivers/Better Profitability?

|Includes: Fred's, Inc. (FRED)
Interesting restructuring story developing with FRED 

What is interesting :

a.) improving operating margins
b.) under performing store closings
c.) leaner inventory monitoring enacted in 2009
d.) lower exposure to discretionary cutbacks
e.) better focus on mix
f.)  push into pharmacy format 

What hinders my bullish thesis

a.) optimistic guidance from management was revised lower in Q4
b.) Co. still sees continued consumer cautiousness through Q1 
c.) flat comparable store sales and EPS for Q1 ($0.15 to $0.20) vs a $0.23 First Call consensus

FY’10 guidance indicates a net sales growth of 1-3% but a flat SSS number. Street estimates at $0.76 for 2010 (company guidance implies $0.81/share) Trading at 0.2x EV/sales and 13x next years forward P/E.
FRED continues to disappoint on its Q's, SSS  continue to disappoint. What is causing the misses?
a.) higher markdowns
b.) bloated operating costs
c.) recognition of revs coming from layaway sales causing drag ~1% of total sales
(These sales are recognized when transaction is completed)
Gross Profit was down 1% on year/year, while margins for first 9 months declined - 60 bps to 29.1%.The decline in margins was attributed to higher markdowns on promotional advertising and a 20 bps impact as a result of 9 store closing.
Co. sees margin improvment coming from a higher mark-up in merchandise and shrink controls.

As of April 3, 2010, it operated 669 discount general merchandise stores, including 24 franchised stores

Sales mix breakdown is as follows: 35% pharmacy, 21% household, 16% food and tobacco, 10% paper/chemicals, 8% health and beauty, 7% apparel, and 3% franchise.

Another interesting development:  
Cash Improved to $38.6 Million from $8.5 Million Y/Y comparison (or ~ $0.97/share). Working capital saw favorable effect as inventories decreased. The average inventory per store reduced by 9%, Cap Ex. slightly higher Y/Y as remodeling and new concept stores being rolled out. Accounts Payable stood at 35% of inventory up from 32% prior year. Total Debt stood at $5 Million and no borrowing under revolver line. Furthermore has a 3.7 million share buy back authorization (~39 Million outstanding)

Reasons why I am getting bullish:
a.) continued roll out and focus on pharmacy concept b.) Continued stress on improving cash flow c.) debt free d.) share buyback e.) productivity per square foot continues to improve f.) major rebranding initiative to take hold in 2010 g.) remodeled stores showing double digit comp growth h.) initial mark-ups starting to take hold
Things to remain cautious about i a.) cost associated with re-modeling through 2011 b.) continued increased promotional activities c.) flat comps d.) flattening out of new remodeled stores e.) pharmacy script margins pressured due to competitive landscape (ie: WMT) f.) lower Medicaid reimbursement levels g.) management shaky comments on 2010 estimates

Disclosure: No Position, But Waiting For Confirmation of A Good Quarter