Gap (GPS) Up On Q3 Sales & Earnings Beat, Cuts Sales View

The Gap Inc. (NYSE:GPS) reported top and bottom-line beat in third-quarter fiscal 2019, while the metrics declined on a year-over-year basis. Soft performance across all brands as well as weak traffic trends mainly impacted the results.

Nonetheless, shares of Gap rose 1.7% in the after-hours trading session on Nov 21, owing to the earnings and sales beat. In the past three months, shares of the Zacks Rank #4 (Sell) company have lost 4.1% against the industry’s 7.4% growth.

Management lowered its sales and comparable sales (comps) view for fiscal 2019. Nevertheless, it reaffirmed the outlook for adjusted earnings per share.

Q3 Highlights

In the fiscal third quarter, Gap’s adjusted earnings of 53 cents per share surpassed the Zacks Consensus Estimate of 51 cents. However, the bottom line declined 23.2% from 69 cents registered a year ago. On a reported basis, the company delivered earnings of 37 cents per share.

Net sales dipped 2.2% year over year to $3,998 million but beat the Zacks Consensus Estimate of $3,951 million. Foreign currency translations negatively impacted the top line by $12 million. Total comps declined 4% compared with flat results in the year-ago period.

Comps were impacted by declines across all three brands mainly due to soft traffic trends. Notably, comps declined 4% at Old Navy versus 4% improvement in the prior-year quarter. At Banana Republic and Gap brands, comps declined 3% and 7%, respectively. In the year-ago quarter, comps rose 2% at Banana Republic and declined 7% at the company’s namesake brand.

Comps decline in Old Navy can be attributed to continued challenges in product acceptance as well as weak traffic. Meanwhile, the Banana Republic brand was mainly affected by softness in some products due to the warmer-than-expected weather along with sub-optimal mix regarding sizes, owing to efforts to fully implement a new inventory management tool. Though the Gap brand reported comps decline, sales trends were positive due to traffic improvement across all channels on continued improvement in customer response to products.

Margins

Adjusted gross profit in the quarter under review dropped 3.9% to $1,560 million and gross margin contracted 70 basis points (bps) to 39%. The decline, however, reflected an improvement from the trend witnessed in the first half. Gross margin gained from improvement at the Gap brand, owing to margin expansion in all major product divisions and positive global average unit retail (AUR). This was offset by softness in the Old Navy brand.

Further, merchandise margin contracted 50 bps mainly due to Old Navy and Banana Republic, somewhat mitigated by Gap and Athleta brands. Meanwhile, rent and occupancy increased 20 bps due to lower sales. Adjusted SG&A expenses expanded 70 bps on lower sales as well as higher technology-related investments.

Consequently, adjusted operating income declined 17.6% to $299 million, with adjusted operating margin contracting 140 bps to 7.5%.

Financials

Gap ended the fiscal third quarter with cash and cash equivalents of $788 million, long-term debt of $1,249 million, and total stockholders’ equity of $3,634 million.

During the first nine months of fiscal 2019, the company generated net cash flow from operations of $528 million and incurred capital expenditure of $523 million. As of Nov 2, 2019, Gap had free cash flow of $5 million due to higher capital spending.

Coming to the shareholder-friendly moves, the company bought back 2.9 million shares for approximately $50 million and paid out a dividend of 24.25 cents per share in the fiscal third quarter. Furthermore, it announced a dividend payout of 24.25 cents per share for fourth-quarter fiscal 2019.

For fiscal 2019, management projects capital expenditure of $835 million, including base capital of $575 million for investment in profitable Old Navy and Athleta brands as well as in technology and supply-chain initiatives. It anticipates capital expenditure to comprise $100 million of expansion charges related to its headquarters building and the development of distribution facility in Ohio, and $160 million of separation-related capital spending.

In fourth-quarter fiscal 2019, management expects to buy back shared worth of $50 million.

Store Update

In the first nine months of fiscal 2019, the company opened 85 Old Navy and Athleta stores, on a net basis, and acquired 140 Janie and Jack stores from Gymboree, Inc. Meanwhile, it closed 21 Gap brand stores primarily in North America, net of openings that mainly occurred in Asia.

Gap ended the fiscal third quarter with 3,938 outlets in 44 countries, out of which 3,396 were company-operated and 542 were franchise outlets.

For fiscal 2019, the company now expects the closure of 15 company-operated stores, net of openings and repositions. The projection also includes the closure of 130 stores related to the restructuring of the Gap brand fleet. Most of these store closures are expected to occur in fourth-quarter fiscal 2019. Simultaneously, it remains committed toward store openings for Athleta, Old Navy and Gap China locations.

However, the company decided on Old Navy’s exit from China in early 2020 to direct investments toward other high-return opportunities like expanding digital capabilities and investing in the underpenetrated North America markets that provide better opportunities.

Outlook

For fiscal 2019, management cut sales and comps guidance, owing to continued troubles at its brands and soft traffic trends. However, it reiterated the view for earnings per share.

The company now anticipates comps decline in mid-single digits compared with low-single-digit decline mentioned earlier. Moreover, it now expects net sales decline in low-single digits versus flat year-over-year sales stated previously.

Gap expects effective tax rate of 31%. Excluding adjustments to fiscal 2017 tax liability under TCJA and certain non-cash tax impacts with respect to anticipated restructuring charges, the company continues to anticipate adjusted effective tax rate of 26%.

Nonetheless, Gap envisions fiscal 2019 GAAP earnings of $1.38-$1.47 per share, with adjusted earnings per share of $1.70-$1.75.

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