Shares of The Gap, Inc. (GPS) dropped 3.7% in the after market trading session yesterday, as the company’s third-quarter fiscal 2014 adjusted earnings of 74 cents a share missed the Zacks Consensus Estimate of 79 cents. However, earnings improved 2.7% on a year-over-year basis.
Including a 6 cents per share gain from a non-recurring tax benefit during the quarter, the company reported earnings of 80 cents a share.
Net sales of this Zacks Rank #4 (Sell) company dipped marginally by 0.1% year over year to $3,972 million, coming way below the Zacks Consensus Estimate of $4,015 million. Sales were hurt by the negative impact of foreign currency translations.
However, on a constant currency basis, net sales inched up 1%. Also, with continued focus on developing its omni-channel network, Gap’s quarterly online sales came in at $621 million, up 5.4% from the prior-year quarter.
Further, third-quarter comparable-store sales (comps) inched down 2%, against a 1% improvement last year. Going by brands, Gap Global comps dropped 5% against a 1% rise last year. Comps at Banana Republic Global remained flat, as compared to a 1% fall last year. Old Navy Global comps displayed a 1% increase, while it had remained flat last year.
The company reported a marginal improvement of 0.4% in its gross profit to $1,569 million with the gross margin growing 20 basis points (bps) to 40.2%, primarily due to a 90 bps improvement in merchandise margins.
However, operating income slipped 3.8% to $554 million, leading the respective margin to contract 60 bps to 13.9%. This fall came as a result of a hike in operating expenses, which rose roughly 3% to $1.04 billion during the quarter. Moreover, marketing expenses escalated $14 million to $176 million owing to increased expenditures at the Gap brand.
Financials
This apparel and shoe retailer ended the quarter with cash and cash equivalents of $954 million, long-term debt of $1,358 million and total shareholders’ equity of $2,855 million. On a comparable basis, the company had cash and cash equivalents of $996 million, long-term debt of $1,247 million and total shareholders’ equity of $2,956 million as of Nov 2, 2013.
Moreover, the company generated free cash flow of $606 million, while it incurred $508 million as capital expenditures year-to-date.
Gap now intends to spend $700 million as capital expenditures in 2014, down from its previous guidance of $750 million. However, these persistent capital-spending initiatives highlight the company’s focus on investing in strategic plans.
Dividend & Share Repurchase
Focused on its policy of returning excess cash to shareholders through dividends and share repurchases, the company has distributed over $1.3 million to shareholders as of Oct 2014.
During the third quarter, Gap paid its shareholders a cash dividend of 22 cents a share and bought back 11.4 million shares for a total price of $433 million. Also, the company had nearly $450 million remaining under its recent authorization of $500 million, announced on Oct 16.
Store Update
Gap’s third-quarter fiscal 2014 results reflected significant progress of the company’s ongoing strategy of globally expanding its brands. In keeping with this strategy, the company is on track to end fiscal 2014 with a total of 110 Gap brand stores across mainland China, Hong Kong and Taiwan, and 100 U.S.-based Athleta stores. Also, as for the Athleta brand, the company opened 14 stores during the quarter, bringing its count to 92 by the quarter end.
The company specifically plans to strengthen the foothold of its Old Navy brand in China and is attempting to reach seven stores across five cities by the year-end. Also, management announced plans to open franchise-operated stores of this brand in six Middle Eastern countries, from Spring 2015.
In total, Gap opened 84 new stores, while it shut down 18 company-operated stores during the quarter. This brings the company’s total store count to 3,680 across 50 countries with 3,266 company-operated and 414 franchise outlets, increasing its company-operated floor space by 2.2% year over year.
In fiscal 2014, Gap still intends to open 185 company-operated outlets, barring relocations, with primary focus on China, Old Navy in Japan, Athleta and global outlet stores. It also plans to shut down 70 company-operated outlets, primarily inclined toward Gap North America. The company reiterated its target of a 2.5% rise in net square footage in fiscal 2014.
Outlook
Gap now anticipates 2014 earnings in the range of $2.73–$2.78 per share, compared to $2.95–$3.00 per share projected earlier. This guidance includes the impact of a $39 million gain on the sale of an asset.
Further, management anticipates operating margin for the full year to come around 12.5%, versus 13.3% reported in 2013. Effective tax rate for the fiscal is expected to be 38%, down from 38.5%, predicted earlier.
Overall, though management was not very pleased with the company’s third-quarter performance, it was satisfied with its expense and inventory management initiatives. Going forward, it remains hopeful of the upcoming holiday season.
Better-ranked stocks in the same industry include American Eagle Outfitters, Inc. (AEO), Bebe Stores, Inc. (BEBE) and L Brands, Inc. (LB). All these stocks hold a Zacks Rank #2 (Buy).
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