Gap Inc Earnings Preview: Bottom line Growth And Younger Brands In Focus

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Apparel major Gap Inc (NYSE:GPS) is scheduled release its Q3 fiscal 2014 results on November 20th. During its October sales release, the company had reported its comparable sales growth metric for the third quarter. The retailer had stated that its comparable sales in the quarter ended November 1, 2014 declined 2% as compared to 1% increase in the same quarter last year. Gap Inc’s namesake brand was the biggest concern during the quarter, as its comparable sales fell by 5% versus 1% increase in the year ago period. Comparable sales remained flat at Banana Republic but increased by a paltry 1% at Old Navy. For some time now, the retailer’s mainline brand and Banana Republic have struggled due to their premium prices, while relatively cheaper Old Navy has grown at a decent pace. However, the brand’s slow growth in Q3 against flat growth in the same quarter last year is a little unsettling.

While Gap Inc’s top line growth is expected to remain subdued, the company is set to report better-than-expected profits. During its October release, the retailer had said that its Q3 fiscal 2014 earnings per share will be in the $0.78-$0.79 range, several cents ahead of the consensus estimate of $0.71. [1] The main reason behind the company’s promising Q3 EPS guidance is its relatively lower effective tax rate as compared to Q3 fiscal 2013. If Gap Inc reports Q3 profits in the guided range, it would reflect an year-over-year increase of 8%-10%. The retailer even said that its gross margins and operating expenses will be better than its previous guidance. It must be noted that the company had raised its full year EPS outlook from $2.90-$2.95 to $2.95-$3.00 at the end of the second quarter. If Gap Inc’s bottom line growth actually turns out better than its previous expectations, we might see the retailer revising its full year guidance again.

Our price estimate for Gap Inc is at $51.86, implying a premium of more than 30% to the market price.

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See our complete analysis for Gap Inc.

Gap Inc was unable to benefit from industry-wide retail sales growth during the August-October quarter due to its weak online presence. U.S. retail sales in the three month period increased at an average of 4.5%, but foot traffic across the industry declined at an alarming rate. This is attributable to the fact that U.S. buyers have been increasingly switching to online shopping from brick-and-mortar shopping. This trend has had a negative impact on sales growth of several retailers including Gap Inc, whose online channel isn’t big enough to drive the overall revenue growth. According to ShopperTrak, a firm that tracks store traffic in over 40,000 outlets across the U.S., store visits have fallen consistently by close to 5% year over year in all the months of the past two years. Even in August, 4.7% fewer shoppers went out for shopping as compared to the previous month. [2] To better understand the intensity to traffic decline, it is worth noting that store traffic in September 2014 was 17% below what it was in the same month last year. [3] With significantly fewer shoppers as compared to last year, it is somewhat clear why Gap Inc was unable to register positive growth during the quarter.

Since Gap Inc has already released comparable sales growth metrics for its main brands, it will be interesting to see how its younger brands (Athleta, Intermix, Piperlime etc.) fared during the quarter. Though their contribution is insignificant at the moment, they will play a crucial role in the long run and help Gap Inc gain share in the saturated U.S. apparel market. The company has been expanding these brands aggressively over the past several quarters, which most likely continued in the recently concluded quarter as well. It will be very interesting to see how the retailer plans the expansion of these brands (especially Athleta), given that the future of store shopping seems to be dimming, but the brands still need an optimum presence in the country. Athleta had 79 stores operational at the end of the second quarter of fiscal 2014.

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Notes:
  1. Gap Inc Reports October And Third Quarter Sales Results, Gap Inc, Nov 6 2014 []
  2. Back-To-School Slump Raises Concerns About The Holiday Season, Bloomberg, Sept 23 2014 []
  3. U.S. Retail Benchmarks Show Decline in Store Traffic, Business Solution, Oct 21 2014 []