Gap Inc Earnings Preview: Sluggish Premium Brands To Offset Steady Old Navy

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Apparel major, Gap Inc (NYSE:GPS) is scheduled to release its Q2 fiscal 2014 earnings on August 21. In a recent press release, the company stated that its Q2 comparable sales growth was flat as compared to 5% increase witnessed in the same quarter last year. While Gap Inc displayed tremendous resilience against the edgy retail environment last year, it hasn’t performed well this year. During the first quarter, the retailer’s comparable sales decreased by 1% with 5% decline at its mainline brand partially offset by 1% growth at Old Navy. In the second quarter, while Gap Inc managed to post positive comparable sales growth during May and July, its dismal performance in June weighed heavily on its results. The company reported 2% decline in its comparable sales during the month with staggering 7% decline at both — Gap and Banana Republic.

Although customers are spending less on Gap Inc’s relatively expensive brands, they have resonated very well with its affordable brand Old Navy. The brand registered positive comparable sales growth in all the three months of the quarter, while Gap’s growth was positive in none. Old Navy’s healthy 4% comparable sales growth in Q2 helped the company match its previous year’s level despite 5% decline at Gap and flat growth at Banana Republic.

Our price estimate for Gap Inc is at $50.50, implying a premium of about 20% to the market price.

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See our complete analysis for Gap Inc.

Tough June Weighed Heavily on the Company’s Premium Brands

Gap Inc’s sales are somewhat related to the macro-economic trends in the U.S., given that it is one of the biggest apparel chains in the country. Since U.S. buyers weren’t as confident in spending in June 2014 as they were a year earlier, sales of the company’s premium brands suffered. While the U.S. consumer confidence in June 2014 stood high at 81.2, it was well below June 2013′s figure of 85, which was the highest in over six years. [1] This indicates why Gap Inc performed very well in June last year. The retailer’s overall comparable sales had increased by 7% in June 2013 with 5% growth at Gap, 1% growth at Banana Republic and 13% rise in comparable sales at Old Navy.

Due to slightly rougher environment in June this year, Gap Inc was not able to match its stellar June 2013 performance. Comparable sales at its relatively expensive brands, Gap and Banana Republic, declined by a wide 7%. This even prevented the company from realizing positive comparable sales growth in Q2. However, we do not attribute the retailer’s dismal performance entirely to the sluggish macro-economic environment. There exists a possibility that Gap Inc might have made a few off-pitch fashion calls. We will have to wait for its Q2 earnings call to find out.

Affordable Brand had an Offsetting Impact

Gap Inc’s Q2 performance wasn’t bad across the board. Its affordable brand Old Navy grew steadily throughout the quarter. The brand’s comparable sales grew 2% in May, 7% in June and 3% in July. This can be attributed to the brand’s vast reach in the U.S. and improving consumer outlook with better job scenario. Unemployment rate declined to 6.3% in May 2014 from 7.5% in the same month last year. It fell to its lowest value in more than six years (6.1%) in June and increased only slightly to 6.2% in July. [2]

Cheaper apparel brands enjoyed this trend as more buyers could afford to spend on value-for-money clothing. Affordable teen apparel retailer, Zumiez, reported better-than-expected 3.1% growth in June and 3.5% growth in July. With affordable brands doing well, Old Navy’s steady growth throughout the quarter was able to offset the impact of significant comparable sales decline at Gap and Banana Republic in June.

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Notes:
  1. United States Consumer Sentiment, Trading Economics []
  2. Labor Force Statistics from the current Population Survey, Bureau Of Labor Statistics []