Gap Inc Earnings Preview: Premium Brand Weakness & Currency Headwinds To Offset Consistent Old Navy

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Apparel leader  Gap Inc (NYSE:GPS) is scheduled to report its Q1 fiscal 2015 earnings on May 21st, but it has already released its sales growth metrics for the quarter. In a press release earlier this month, the retailer announced that its net sales on a reported basis fell 3% to $3.66 billion from $3.77 billion in the year ago period. The company’s growth was weighed down by negative currency headwinds owing to the strengthening dollar and continued weakness in its namesake brands. Although Gap Inc’s affordable brand Old Navy continued to grow steadily in the first quarter, its growth wasn’t strong enough to pull the company out of the slump. While Gap and Banana Republic are having trouble attracting customers as such, the persistent decline in foot traffic across the apparel industry and Gap Inc’s relatively small online channel have added to their problems.

During the quarter, Gap’s global comparable sales were down 10% on top of 5% decline in the year ago period. Partially responsible for this decline was the strong dollar, which is suppressing the incoming revenues from international markets. For Banana Republic, comparable sales were down 8% on top of 1% decline last year, but Old Navy’s growth metric stood at 3% for the quarter, while it was just 1% in the same quarter last year. Growth in comparable sales was somewhat slow by Old Navy’s standards, but some of that is attributable to the negative currency headwinds. Overall, Gap Inc posted a negative 4% change in comparable sales. It must be noted that the company’s comparable sales include e-commerce revenues, a segment which has been unable to offset the impact of weak store traffic despite its strong growth. Considering that Gap Inc’s online channel is quite small as compared to its vast store fleet, it cannot do much for the company’s overall growth.

Gap Inc said that it will post earnings per share in the $0.55-$0.56 range, with $0.02 positive impact of reversal of interest expense. It even said that inventory dollars per store is expected to be up 4% year over year, which implies that the retailer did not have the best of quarters in terms of inventory management, which makes sense given that store traffic in the earlier part of the quarter was lower-than-expected on account of bad weather. [1]

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Our price estimate for Gap Inc is at $52, implying a premium of about 30% to the market price.

See our complete analysis for Gap Inc.

Gap Inc has been trying hard to get its iconic brand Gap back on track and we believe that it has the ability to do so. Founded in 1969, the company has turned this brand into one of the most popular casual apparel brands in the U.S. Although it hasn’t performed at par with the company’s expectations lately due to its relatively premium prices and growing consumer affinity towards affordable fast fashion brands such as Zara and Forever 21, it can win back customers by proactively employing new merchandise strategies and leveraging its vast reach and deep understanding of the market. In fact, the company hired a new design head a while back in order guide the brand out of the slump. During the earnings call, we will keep an eye out for any signs of recovery in the brand’s underlying performance. Gap Inc’s Banana Republic brand has also suffered due to a pullback in consumer spending on discretionary products as well as growing competition from the aforementioned fashion forward players. Although the brand offers a compelling range of versatile workwear, with a good amount of fashion content, its pricing is not resonating well with customers. The retailer may need to revisit the pricing strategies for its affordable luxury brand.

Gap Inc said in its April sales release that currency headwinds had a significant negative impact on its Q1 growth. The retailer said that strong dollar had a negative effect of almost $90 million on its first quarter sales, and excluding its impact first quarter sales declined just 1%. A lot of companies with global operations have been struggling for growth lately as dollar has appreciated significantly against other currencies and it is likely to sustain this momentum throughout 2015. For Gap Inc, international sales account for over 20% of its overall revenues and even though it is growing in its international markets in constant currencies, that growth isn’t translating into growth in revenues. The retailer mentioned that weakening of Japanese yen and Canadian dollar were among the main factors responsible for its sluggish growth.

Store traffic across the industry continues to fall with buyers in numbers moving to online shopping encouraged by the convenience and incentives associated with it. For surviving through this shift and ensuring they make the most of growing web shopping interest, store based retailers including Gap Inc are gradually adopting omni-channel retailing. So far, impact on overall growth has been minimal as retailers with a small web channel are losing more from a decline in foot traffic than they are gaining from incremental online sales. However, it is certain that eventually omni-channel retailing will play a crucial role in driving growth for Gap Inc, provided it moves swiftly towards its goal. Hence, it is worthwhile monitoring the company’s progress on its omni-channel initiatives.

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Notes:
  1. Gap Inc Reports April and First Quarter Sales Results, Gap Inc, May 11 2015 []