Gap Inc Fumbles In October, But Issues Better-Than-Expected EPS Guidance For Q3

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Apparel major Gap Inc (NYSE:GPS) recently reported its October sales results and provided an update on its Q3 fiscal 2014 earnings. The company’s comparable sales for the month fell by 3% as compared to 4% increase in the same quarter last year. The results were particularly disappointing at Gap, where comparable sales declined by almost 7%, following 5% increase in the year ago period. Comparable sales at Old Navy remained flat, while they declined by 2% at Banana Republic. For the past several quarters, while the retailer’s namesake brand and Banana Republic have struggled for growth due to their premium prices, relatively cheaper brand Old Navy has grown at a healthy pace. However in October, even though Old Navy performed better than Gap and Banana Republic, it was unable to register positive growth against a mild comparable period (2% increase in the same quarter last year), which is a concern for the company. [1] Gap Inc’s financial performance has faltered over the past few quarters and its CEO’s retirement announcement has made investors skeptical. Hence, the company needs to rectify its topline growth problems in the near term, or at least maintain its strength with Old Navy while other brands recover gradually.

Our price estimate for Gap Inc is at $51.86, implying a premium of less than 35% to the market price.

See our complete analysis for Gap Inc.

Why Gap Inc Stumbled in October Despite Good Market Conditions?

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Despite being one of the biggest apparel retailers in the U.S., Gap Inc was unable to register positive comparable sales growth in October, even when the retail environment was good. Encouraged by promising jobs data, U.S buyers opened up their wallets during the month, which resulted in 4% year-over-year growth in U.S. retail sales. The unemployment rate fell to a five year low of 5.8%, which had a positive impact on consumer sentiment. In fact, unemployment rate in October 2014 was 1.4 percentage points below what it was in the same month last year. [2] The Thomson Reuters/University of Michigan’s U.S. consumer sentiment index rose to 86.9 in October, which was its highest value in over seven years. [3] As a result, U.S. buyers were more generous with their spending during this year’s Halloween shopping, which resulted in strong retail growth during the fourth week of the month. [4] However, Gap Inc was unable to benefit from the growth in retail sales during the month. U.S. buyers have been increasingly switching to online shopping due to its convenience and cost benefits. Since most of the retail growth in October can be attributed to the surge in online orders, Gap Inc’s weakness becomes evident. The retailer still relies on store sales for close to 90% of its revenues and store traffic in October this year was significantly less than its last year’s levels. According to ShoppeTrak, store traffic has declined by 5% in almost all the months during the last two years, and about 17% fewer shoppers visited physical stores in September as compared to the same month last year.

Third Quarter Update

Even as Gap Inc’s comparable sales declined 3% during October and missed consensus estimate of 1.9% decline, its shares ticked up a little on better-than-expected Q3 profit guidance. The company expects its EPS to be in the $0.78-$0.79 range in Q3, while analysts were expecting the figure to be around $0.71. The retailer even said that its gross margins and operating expenses will be better than its previous guidance. However, Gap Inc’s topline growth remains disappointing as its comparable sales in the third quarter declined by 2% on top of 1% increase in the same quarter last year. As was the case in October, mainline brand Gap remained the biggest concern with 5% decline in its comparable sales. Banana Republic was flat and comparable sales at Old Navy improved a paltry 1%. The company will report its Q3 earnings on November 20.

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Notes:
  1. Gap Inc Reports October And Third Quarter Sales Results, Gap Inc, Nov 6 2014 []
  2. Labor Force Statistics from the Current Population Survey, Bureau of Labor Statistics []
  3. U.S. consumer sentiment at highest since July 2007, Reuters, Oct 31 2014 []
  4. U.S. Retail Sales Rise in October from September – Redbook, Nasdaq, Nov 4 2014 []