Online And Franchise Businesses Will Drive Gap’s Q3 Results

by Trefis Team
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GPS
Gap Inc.
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Gap Inc. (NYSE:GPS) is set to release its Q3 fiscal 2012 earnings on November 15. In a preliminary press release, the retailer stated that its Q3 net revenues have increased 8% y-o-y while same store sales for October 2012 were up 6% compared to the same period last year. [1] We believe Gap’s success in online and franchise businesses is the primary factor behind the healthy revenue growth. However, its international comparable store sales decreased by 3% owing to the tough economic environment in Europe, but was slightly better than last quarter’s 5% decline. [2]

See our complete analysis for Gap Inc.

Online And Franchise Businesses Driving Growth

Last quarter, Gap’s direct business sales increased by 24% y-o-y driven by its strong presence in the online segment and increased investment in direct business. This resulted in a 4% increase in same store sales which were evenly distributed across segments: Gap North America (7%), Banana Republic (7%) and Old Navy (3%). The trend continued in Q3 with comparable store sales increases of 7%, 6% and 9% respectively. [1] Growth in online business, and the introduction of more unit inventory at Old Navy stores are the main factors contributing to growth in same store sales.

As far as the franchise business is concerned, it is supporting Gap’s overall revenue growth despite a decline in comparable store sales in international markets. While the decline in international comparable store sales was 5% last quarter, it reduced to 3% in Q3. The slowing European economy and weakness in store traffic in Japan, which is still recovering from last year’s natural disaster, continue to affect Gap’s international business.

Nevertheless, the company’s total sales were up 6% last quarter with international revenue increasing by 7%. The growth was assisted by revenue growth of  25% y-o-y in Gap’s franchise business attributable to store expansion in new markets. Gap added 10 outlets globally in the second quarter and its first Old Navy store in Tokyo has received a positive response. We expect the franchise business’ contribution will continue to boost Gap’s international business in Q3.

Marketing Costs May Remain On The Higher Side

The apparel industry is highly promotional and a retailer’s success largely depends on its marketing strategies. In order to increase traffic to its stores, Gap increased its marketing expenses by around 30% in Q2 fiscal 2012. A significant portion of this was invested on storefront windows, outdoor, digital and social media. In North America, the retailer is driving “Be Bright” marketing campaign. We expect these efforts to have a positive impact on same store sales growth, but will likely result in higher operating expenses.

Our price estimate for Gap Inc. at $ 40, implying a premium of about 10% to the market price.

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Notes:
  1. Gap Inc. Reports Increase in October Sales and Strong Third Quarter Sales Results, Gap Inc., Nov 1 2012 [] []
  2. Gap’s Q2 fiscal 2012 earnings transcript, Aug 16 2012 []
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