Gap Inc’s Earnings Highlight Its Lingering Weakness

Gap Inc‘s (NYSE:GPS) shares slid 5% in after hours after it reported a substantial decline in its Q4 profits and guided 2017 EPS way below analysts’ estimates. The contributing to its lackluster performance and guidance are the negative currency headwinds, fierce competition from fast-fashion companies who continue to nibble other retailers’ customer base, and Gap Inc’s poorly positioned merchandise. While the retailer cannot do much about the strengthening dollar, it needs to improve its underlying performance to give investors some relief.  Even Old Navy’s performance, which was the only bright spot in Gap Inc’s recent performance, has faltered lately. However, CEO Art Peck believes that progress on the company’s core priorities — fashion, customer experience and inventory management — has been good so far and it should have a positive impact on sales in the near future. What’s uninspiring is that the company did not talk much about its omni-channel progress and International performance during its earnings call, which suggests that there has not been any significant progress on these fronts.

Our price estimate for Gap Inc is $31, implying a 10% premium to the current market price. However, we are in the process of updating our model in line with the recent earnings release.

See our complete analysis for Gap Inc.

Earnings And Guidance Disappoint

Gap Inc’s revenues were down 5% and 4% for the fourth quarter and for the full year, respectively. Gross margins for the year were down almost 200 basis points owing to the retailer’s traffic driving promotional activities. On the plus side, operating expenses were down three percentage points relative to revenues, thanks to the closure of underperforming stores. However, the pressure on gross profitability  and lower interest income pummeled the company’s EPS, which fell 23% to $2.24 for the full year. Even for the quarter, EPS was down almost 30% to $0.54. For the current year, Gap Inc expects to generate per share profit in the $2.20-$2.25 range, which is well below the consensus estimate of $2.42. Considering that this is year when the retailer’s premium brands are supposed to take off (according to the company), the guidance appears even more disappointing. However, much of it can be attributed to currency headwinds, which are expected to play a big role in suppressing the profits for 2017. Gap Inc’s guidance includes a pre-tax negative impact of $120 million.

Results Highlight Long-Standing Struggle

Casual apparel retailers in the U.S. have all suffered at the hands of fast-fashion brands such as Zara, Forever 21 and H&M, who have been consistently driving store traffic with their affordable merchandise and quick inventory turnover. Gap Inc, being one of the biggest casual apparel retailers in the U.S., has not been immune to this impact either. It has lost customers’ purchases (mainly from Gap and Banana Republic) to the aforementioned fast-fashion companies.  On top of this, revival strategies have not taken effect so far. To make things worse, Gap Inc’s new merchandise collections across its brands lately have not been too impressive. In fact, CEO Art Peck mentioned that the brands have even stumbled on the very basics of apparel such as proper fit, which in the prevailing scenario is unacceptable. In addition to company specific problems, the strengthening dollar has also plagued the apparel major, suppressing revenues coming in from the international markets. During fiscal 2015, Gap Inc experienced a total negative impact of $363 million on its topline, which played a vital role in its revenue decline.

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