The Gap, Inc. GPS has been struggling, thanks to dismal comparable sales (comps) trend in the past few quarters. We note that the San Francisco, CA-based company came under pressure after third-quarter fiscal 2019 results, which were impacted by persistent soft performance across all brands as well as weak traffic trends. Also, strained margins and higher expenses remain added concerns. Moreover, management cut sales and comps guidance.
In the past year, shares of the Zacks Rank #5 (Strong Sell) company have dipped around 31%, underperforming the industry’s decline of 20.4%.
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The company’s total comps declined 4% in third-quarter fiscal 2019 compared with flat results in the year-ago period. Comps were impacted by declines across all three brands mainly due to soft traffic trends. Comps declined 4% at Old Navy, 3% at Banana Republic and 7% at the Gap brand.
Old Navy’s comps were affected by continued challenges in product acceptance as well as weak traffic. The Banana Republic brand was impacted by softness in some products due to warmer-than-expected weather along with sub-optimal mix regarding sizes, owing to its efforts to fully implement a new inventory management tool. The Gap brand reported comps decline due to store closures.
In addition, adverse foreign currency fluctuations weighed on the company’s sales, which dipped 2.2% in the fiscal third quarter. In addition, adjusted gross margin contracted 70 basis points (bps) on softness in the Old Navy brand. Merchandise margin contracted 50 bps, mainly owing to softness in Old Navy and Banana Republic, somewhat mitigated by Gap and Athleta brands. Adjusted SG&A expenses expanded 70 bps on lower sales as well as higher technology-related investments. Consequently, adjusted operating margin declined 140 bps.
Apart from these, the company expects gross margin to deleverage in fiscal 2019. It now anticipates comps decline in mid-single digits compared with a 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.
Is There Hope for Revival?
Gap is on track to spin off into two stand-alone public companies, new Gap Inc. and Old Navy. The transaction is expected to close in 2020. The rationale behind the separation mainly includes improved focus, better cost and efficiency, and enhanced profitability. The improved focus from separation will help two companies better serve their distinct customer sets, each with an operating model tailored to their respective business needs. It will also serve as a catalyst for improving costs and efficiency as the companies rebuild the organization structures and operating models. Moreover, it will empower both companies to deliver sustained profitability.
Management remains on track to revitalize the Gap brand by streamlining its specialty fleet and enhancing the marketing model to drive customer engagement. The company is also focused on driving profitability through improved product assortment and inventory composition as well as reduced promotional activity. Though it has a long way to go before restoring the brand to profitability, results in the third quarter of fiscal 2019 were relatively better. The company witnessed positive margins and traffic trends for the Gap brand in the fiscal third quarter, owing to its efforts to drive profitability through improved product assortment and inventory composition as well as reduced promotions.
We believe that these efforts will take time to yield favorable results and win investors’ confidence on the stock. However, the current dismal performance remains concerning for the company in the near term.
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