Gap Inc February Results Confirmed Its Fiscal 2015 Concerns

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Last month, after its Q4 and fiscal 2015 earnings release, apparel major Gap Inc (NYSE:GPS) issued a frail guidance for fiscal 2015 stating that strengthening dollar and inventory delays due to West Coast port congestion will weigh heavily on its growth. Soon after, it released its February sales results, that were disappointing by its standards. For the four week period ending February 28, the company reported net sales of $918 million, reflecting a year over year decline of 1.2%. Comparable sales for the period were down 4%, which is not alarming as such, but considering that this was on top of 7% decrease witnessed in the same month last year, it does raise some concerns. By Brands, Gap’s comparable sales fell 7% on top of 10% decline and Banana Republic’s comparable sales were down 5% as compared to -7% in the same month last year. While these brands have been the company’s weak link for some time now, its lone performing brand Old Navy also hit a roadblock in February. The brand could barely meet its last year’s comparable sales levels, even though they had declined 6% in the year ago period. [1]

Gap Inc had ample concerns for its fiscal 2015 growth and February results have somewhat confirmed its fears. The retailer had guided its earnings per share for fiscal 2015 at $2.75-$2.80, reflecting a year over year decline of -4% to -2%, and notably below analysts’ consensus estimate of $3.01. Although a single month’s results are not enough to gauge Gap Inc’s fiscal 2015 performance, they shed ample light on factors that will influence the company’s growth through the year. Even though West Coast labor issues have been resolved with a tentative five-year pact, it will take a few months for operations to return to normal. Meanwhile, retailers such as Gap Inc will continue to suffer due to inventory delays. The U.S. dollar is expected to continue to appreciate against euro and other currencies this year, which will subdue Gap Inc’s growth in international markets, which account for over 20% of its net revenues.

Our price estimate for Gap Inc is at $51.64, implying a premium of less than 20% to the market price.

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West Coast Issues Will Trouble For A Few Months

Increasing incoming shipments at West Coast ports had resulted in traffic jams, that was causing unwanted delays in shipment. Amid this congestion, a tense labor situation was making things worse. Dockworkers and longshoremen, who had been working without a contract since July 2014, became restive. There were complete port shutdowns on several occasions, as the International Longshore and Warehouse Union (ILWU) was trying to retaliate against the Pacific Maritime Association (PMA), which represents the shippers. U.S. retailers such as Gap Inc, who import a significant portion of their merchandise, were at the receiving end of this conflict. Their shipments were getting delayed, which was causing inventory shortages, resulting in weak topline growth. Those who resorted to air freight in order to get their shipments on time, faced significant additional costs that pummeled their profits. Women’s specialty retailer Ann (NYSE:ANN) is one such example.

To retailers’ relief, a tentative agreement between the ILWU and PMA was reached last month that involved 29 ports and 20,000 dockworkers. Though workers have gone back to their usual work, authorities have said that it can take up to 2 months to clear backlog and restore normal operations. [2] In the meantime, retailers will continue to see a delay in their shipments. This clearly indicates that Gap Inc will continue to face problems with its inventory in the near term, that may prove enough to dent its overall fiscal 2015 results.

Negative Currency Headwinds Will Suppress Growth

Dollar has appreciated significantly among other currencies over the past year, signalling the strengthening U.S. economy. Since July last year, it has gained 16% against Euro and 15% against yen. [3] For U.S. retailers such as Gap Inc, Guess (NYSE:GES) and Abercrombie & Fitch (NYSE:ANF), this has suppressed revenues coming in from Europe, Japan and other Asian markets. For instance in Q4 fiscal 2014, while Gap Inc’s earnings per share improved 10% on a reported basis, they increased over 20% on a constant currency basis. Even in February, Gap Inc’s brands’ global growth was below par, which indicates that negative currency headwinds had played a significant role. Through the year 2015 the dollar is expected to appreciate 10% against currencies, which means Gap Inc’s international revenues will feel a formidable downward pressure.

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Notes:
  1. Gap Inc Reports February Sales Results, Gap Inc, Mar 5 2015 []
  2. West Coast port delays could swamp companies for two months, Reuters, Feb 18 2015 []
  3. The winners and losers of a strong dollar, The Washington Post, Jan 23 2015 []