Gap Cuts Full Year Guidance And Promotes Executives To Brand Presidents

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Gap Inc (NYSE:GPS) reported its Q3 fiscal 2014 earnings, which turned out slightly better than the consensus estimate. The company reported 11% rise in its profits to $351 million or $0.80 per share, marginally ahead of the analysts’ estimates of $0.79. [1] However, its revenues fell short of expectations as sales at Gap continued to slip and Old Navy faltered after several strong quarters. Gap Inc’s revenues for the third quarter totaled at $3.97 billion, while analysts polled by Thomson Reuters were expecting the figure to be around $4.04 billion. For the past several quarters, despite the lull in demand for the company’s premium brands, Old Navy had been very strong. Due to this, the retailer was able to maintain a steady growth in its comparable sales. However, the recent slump in Old Navy’s demand has emerged as a big concern for the company. It appears that the brand is finally feeling the impact of significant foot traffic decline across the U.S. apparel industry. Driven by weak sales growth across the board and anticipation of a competitive holiday season, Gap Inc slashed its full year EPS guidance from $2.95-$3.00 to $2.73-$2.78. Following these results, the company’s stock fell by morer than 5%.

While Gap Inc’s results were mostly disappointing, there were a few bright spots. Despite the highly promotional environment, the company’s gross profits improved during the quarter, driven by strong margin performance at Old Navy. While there was a lull in demand during the quarter, Gap Inc was able to maintain its inventory properly, which  prevented unnecessary markdowns.

In other news, the newly appointed CEO, Art Peck, who will take over his responsibilities beginning next year, decided to promote two of the company’s executives to lead Banana Republic and Gap. Jeff Kirwan, current president of Gap Inc China, will become Gap global president in December and Andi Owen, who currently leads the Gap Outlet division, will start working as global president of Banana Republic in January. [2]

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Our price estimate for Gap Inc is at $51.86, implying a premium of less than 30% to the market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Gap Inc.

Good Inventory Management and Fewer Markdowns Despite Weak Demand

Although the overall apparel industry was highly promotional during the back-to-school season, due fierce competition and sluggish consumer spending, Gap Inc was able to operate with fewer markdowns and a firm control over its inventory. This is evident from an improvement in the company’s gross margins and a fall in inventory levels. During the third quarter, Gap Inc’s overall gross profits increased by 0.5%, while its net sales were off by 0.1%. [3] The retailer was able to increase its gross profits despite a fall in sales due to the 20 basis points improvement in gross margins. [4] Even though there was a slump in demand for Gap Inc’s products during the quarter, it did not usher heavy markdowns to compensate for low store traffic, which is evident from its gross margin improvement. What’s even more pleasing to see is that weak demand and fewer promotional activities did not result in inventory hangover. At the end of the third quarter, inventory levels per store were 2% below what they were at the same time last year. Hence, Gap Inc appears to have a clean inventory position for the holiday season, that should help it offer trend and season relevant merchandise, and have an offsetting impact on weak customer demand.

New Presidents for Gap and Banana Republic

With its earnings, Gap Inc issued another press release stating the new CEO has decided to promote a couple of experienced executives to the position of brand presidents for Gap and Banana Republic. Gap global’s current president, Steve Sunnucks will be leaving the company before the end of the fiscal year and Jeff Kirwan, who is serving as the president for Gap China, will succeed him. Mr. Kirwan has done some impressive work in China, which includes aggressive roll-out of e-commerce strategies and expansion of 100 stores in just four years. With his expertise in retail operations and brand development, Jeff Kirwan has successfully handled his responsibilities in other roles as well, that made him a prime contender for the president’s position. We believe that a new leader can provide fresh perspective to a brand that has been struggling for growth.

The current president of Banana Republic, Jack Calhoun, is scheduled to depart from the company on February 1, and he will be succeeded by Andi Owen, who currently leads the Gap Outlet division. During his tenure, Mr. Calhoun has created a global economic model for the brand with his innovative concepts. Andi Owen is most likely to follow in his footsteps, given that she has worked with Gap Inc for close to 25 years, and probably knows the company in and out. She has been successful in several roles with stores, online and merchandising, and has worked for 19 years with Banana Republic alone. She started at Banana Republic with management positions in the field and rose to lead the brand’s factory outlet business.

Old Navy’s slowdown is much more recent as compared to that of Gap and Banana Republic. Understandably, the company wants to put in greater efforts to rejuvenate the growth of its premium brands. That said, Old Navy had been the lone bright spot in Gap Inc results for several quarters and we believe that the retailer needs to simultaneously work on identifying the brand’s shortcomings.

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Notes:
  1. Gap cuts profit forecast as demand slows for Old Navy brand, Reuters, Nov 20 2014 []
  2. Gap Inc. Elevates Two Proven Executives to Guide Gap and Banana Republic Brands into the Next Decade, Gap Inc, Nov 20 2014 []
  3. Gap Inc Reports Third Quarter Results, Gap Inc, Nov 20 2014 []
  4. Gap Inc’s Q3 fiscal 2014 earnings transcript, Nov 20 []