Gap Inc posts surprise profit, shares jump 16% after hours

© Reuters. FILE PHOTO: The Gap logo is seen on the front of the company's store on Oxford Street in London, Britain, July 1, 2021. REUTERS/John Sibley

By Katherine Masters and Ananya Mariam Rajesh

(Reuters) - Gap Inc (NYSE:GPS) on Thursday reported a surprise profit in the first quarter, and its shares jumped 16% in extended trading as the apparel retailer cited restructuring efforts and easing supply chain costs.

U.S. companies are starting to see some relief from sky-high costs of freight and manufacturing after years of supply-chain snags.

Gap's quarterly merchandise margin increased by 610 basis points on an adjusted basis due to lower air freight expenses and improved promotional activity.

The company has seen two consecutive quarters of lower inventory as it works to clear excess apparel purchased last year. Inventory volumes declined 27% from a year earlier, according to Chief Financial Officer Katrina O’Connell.

Gap, like many retailers, sped up its ordering as consumer demand surged during the COVID-19 pandemic, only to be left with piles of unsold inventory as spending normalized.

"It was an okay quarter that was better than expected or feared," said CFRA Research analyst Zachary Warring.

Since September, the retailer has eliminated about 2,300 corporate positions in two rounds of layoffs, joining a set of big U.S. companies that are downsizing in earnest as high inflation eats into consumer wallets.

Interim CEO Bob Martin in a post earnings call said job cuts should contribute to nearly $550 million in estimated annualized savings on a cumulative basis.

Executives pointed to lower spending on salaries and other operating costs in a bid to improve margins, along with efforts to reduce inventories.

The company will have closed about 350 underperforming Gap and Banana Republic stores by the end of the year and plans to open fewer stores this year than projected, O’Connell said.

Still, sales for all Gap's four brands declined in the quarter as the retailer struggled to update inventory and match consumer trends.

"I feel like they've picked a lot of the low-hanging fruit in terms of closing stores and cutting costs," said Mari Shor, a senior equity analyst at Columbia Threadneedle Investments.

"Now you really need Athleta and Old Navy, which are the growth drivers, to return to growth, but I have pretty little confidence in that happening in the near term."

Like major retailers, including Target (NYSE:TGT) and Best Buy, Gap is also witnessing weak demand as lower- and mid-income consumers curb spending on non-essential items such as apparel.

"Sales and sales guidance is worse than peers, but it looks like they are focused on profitability," Warring said.

Gap reported first-quarter adjusted profit of 1 cent, compared with estimates for a loss of 16 cents, according to Refinitiv IBES data.

The company's net sales fell 6% to $3.28 billion. Analysts were expecting $3.29 billion.

Gap maintained its annual sales forecast and expects second-quarter sales to fall in the mid- to high-single digit range. Analysts on average expect second-quarter sales to decline 4.95%.