Gap (GPS) Posts In-Line Q1 Earnings, Draws Strategic Plan

The Gap Inc. (NYSE:GPS) posted first-quarter fiscal 2016 results, wherein its earnings matched estimates for the fifth straight quarter while sales lagged. Additionally, the company provided details on its previously announced strategic actions to enhance business performance and ensure future growth.

Adjusted earnings of 32 cents a share were in line with the Zacks Consensus Estimate but slumped 42.9% from the year-ago quarter earnings of 56 cents. Management highlighted that the company’s earnings per share was hurt by foreign currency fluctuations, which lowered earnings by 2 cents per share and earnings growth by nearly 4 percentage points.

Net sales of $3,438 million dropped 6% from the year-ago figure and missed the Zacks Consensus Estimate of $3,441 million. Currency headwinds affected first-quarter sales by about $20 million.

Comparable-store sales (comps) for the fiscal first quarter declined 5% compared with a 4% fall in the prior-year quarter. Brand-wise, comps for Gap Global were down 3% compared with a 10% drop in the year-ago quarter, while comps for Banana Republic declined 11% against a 8% fall a year ago. Also, Old Navy posted a 6% decline in comps compared with 3% growth in the prior-year quarter.

Gross profit fell 12.5% to $1,209 million, with the gross margin contracting 260 basis points (bps) to 35.2%. This was attributable to rent and occupancy expenses deleverage, lower merchandise margins and currency headwinds.

Operating income plunged 42.5% to $222 million, while the operating margin declined 410 bps to 6.5%, mainly owing to a lower gross margin. However, marketing expenses reduced by $9 million to $127 million in the reported quarter.

Strategic Plans

Keeping track with the accelerated pace of change in the apparel industry, Gap plans to speed up its transformation plan by bringing meaningful changes to its product portfolio and operating capabilities worldwide. The company remains committed to better positioning itself for long-term growth by setting its priorities right and channelizing its resources accordingly.

The company plans to focus on growing its brands in regions which offer greater structural advantage and potential to expand market share. As part of this, the company stated that it will focus on growing its Old Navy brand in the most favorable markets. Consequently, the company plans to close nearly 53 Old Navy stores in Japan in fiscal 2016, and focus on the brand’s growth in North America over the near-term, including its recent debut of company-operated stores in Mexico. Additionally, the company expects China to remain a key area of focus for the entire company.

Outside Old Navy, Japan serves as a major market for Gap’s portfolio housing over 200 Gap and Banana Republic stores. Alongside, the company plans to shut down certain underperforming Banana Republic stores, mainly international, in fiscal 2016. Collectively, the company estimates these actions to result in the closure of nearly 75 stores.

Next, the company remains keen on streamlining its operating model by creating a more proficient global brand structure. By doing this, the company anticipates its brands to better leverage its scale advantages and more quickly ascertain and respond to the changing needs of customers and the retail landscape.

Following implementation, the company expects these actions to deliver annualized pre-tax savings of $275 million and operating margin growth of about 2 percentage points (200 bps). The closure of these stores is expected to attract annualized sales loss of $250 million. Further, store closures and streamlining efforts should result in pre-tax restructuring charges of $300 million in fiscal 2016, of which $100 million are non-cash.

Financials

Gap ended the reported quarter with cash and cash equivalents of $1,313 million, long-term debt of $1,318 million and total shareholders’ equity of $2,522 million. During the fiscal first quarter, the company generated cash flow from operations of $168 million and incurred capital expenditure of $139 million. Additionally, the company’s free cash flow as of Apr 30, 2016 totaled $29 million.

For fiscal 2016, management projects capital expenditure of approximately $525 million compared with the previous guidance of $650 million. The capex will primarily be allocated toward enhancing mobile and supply chain capabilities.

Store Update

In the first quarter, Gap introduced 18 stores, while it shuttered company-operated 17 stores. Gap ended the quarter with 3,727 outlets in 52 countries, of which 3,276 were company-operated and 451 were franchise. Square (NYSE:SQ) footage of company-operated stores declined 1.3% year over year.

In fiscal 2016, the company expects about 50 net closures of company-operated stores. Consequently, the company anticipates square footage growth to drop nearly 2% year over year, down from the previous guidance of flat.

Outlook

Following the first quarter, the company believes that the current First Call consensus earnings per share estimate of $1.92 should hold good, excluding the impact of the aforementioned store closure and streamlining efforts. However, the company believes that the trends in the ever-changing apparel retail industry should improve from the first-quarter levels for this target to be achievable.

Zacks Rank

Currently, Gap carries a Zacks Rank #5 (Strong Sell). Some better-ranked stocks in the broader retail sector include The Children’s Place Inc. (NASDAQ:PLCE) , with a Zacks Rank #1 (Strong Buy), along with Abercrombie & Fitch Company (NYSE:ANF) and New York & Company Inc. (NYSE:NWY) , each carrying a Zacks Rank #2.


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