Fred’s Deals With Pricing Pressures

Fred’s, Inc. (FRED) reported solid second quarter results. Sales were up 5% year-over-year to $447 million with comp-store sales growth of 4.9%, and earnings per share of $0.10. The company previously announced its sales, and its EPS matched the consensus estimate. In addition, the management reiterated its guidance for fiscal 2008. The company expects to earn $0.72-$0.76 per share for fiscal year 2008 and $0.16-$0.18 per share in the third quarter.

However, Fred’s stores target lower-income customers, and those customers tend to be affected to a greater degree by higher energy and food costs. Gas prices remain high, and food prices continue to climb. Elevated food and energy prices are taking a large bite out of what low income households take home every week. Fred’s results will most likely be negatively impacted by further pricing pressures.

With its stock trading at 19.6x our fiscal 2008 EPS estimate and 17.0x our 2009 EPS estimate, Fred’s has limited upside, in our view. Fred’s P/E ratio is in-line with its peers. We think the stock looks fairly valued at current levels. All told, we maintain our Hold rating. Our target price is $15, or about 18x our fiscal 2009 EPS estimate.

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