Will Gap Inc.’s Problems Carry On In 2017?

December 30th, 2016 by Trefis Team
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It has been a dismal 2016 for Gap Inc. (NYSE:GPS), with the company struggling against revenue and comparable store sales declines for the second year in a row. Gap has been unable to post a quarterly comparable sales increase since the fourth quarter of 2014. Banana Republic can be identified as the weak link for the company, with lackluster product assortment pushing customers away from the brand, and with the consumers unwilling to pay the premium prices it once commanded. Consequently, the brand is falling into the same trap as Gap, by resorting to discounting and deals to get rid of the built up inventory. The brand has not reported a positive monthly comparable sales for over a year. This, however, changed in November when the company reported a 5% increase in comps for the brand, and 8% growth, if the impact of a distribution center fire are excluded.

Comps- BR & Gap

See our complete analysis for Gap Inc.

Gap Inc. is facing much of the same problems plaguing the retail industry, the primary one being reduced traffic. While consumers are still willing to spend their money, there has been a fundamental shift in what they are choosing to buy. Shoppers are increasingly moving away from spending on apparel towards more on experiences, such as vacations, eating out, or a concert. This is reflected in the reduced traffic to malls and stores, and record spending on air travels, 8% rise in restaurant sales in the first eleven months of 2016, and growth in spending on media, which includes video games and streaming services such as Netflix and Spotify. This mindset change is proving to be a tough environment for retailers. Many retailers have been trying to overcome this by sprucing up their outlets. For example, Urban Outfitters has opened bars and restaurants within its stores, Barnes and Noble has in-store cafes, and a Target store might feature a Starbucks. Vacations and dining out are expected to get a major chunk of the spending even in the future, with a recent Mintel study pointing out an expected 27% increase between the years 2015 and 2019. The declining foot traffic has been eating into the revenue, which has been steadily falling since 2014. In the third quarter as well, the company reported a 1.5% fall in net sales. As a response to this, the company has been undertaking a number of steps to improve its digital experience. In this regard, the company’s website performance has been improved, and content has been added to boost the shopper’s interest. Furthermore, with a move from desktop or laptop to mobile, Gap has taken an aggressive approach to this space.

Another major problem the company faces is the speed to market of its products. Fast fashion retailers, such as Zara, H&M, and Forever 21, are able to move styles from the runway to the stores within weeks, constantly evolving their assortment and keeping their products fresh. Historically, retailers placed their bets on fashion a year in advance, and since they marked their products higher, there was room for markdowns. However, now companies have realized that by cutting the time down to three to six months, they don’t need to price the items higher. As under the previous CEO Glenn Murphy, Peck is also looking to speed up and improve to the supply chain, and claims significant progress has been made to accomplish this. Gap has been building its responsive supply chain capabilities, in order to buy on a more continuous basis. This will help to deliver “newness” constantly into the stores.

Gap is also bullish on the long term opportunity in China, despite the slowdown in the economy. The Gap specialty and factory stores continue to resonate well with the consumers, and the online business has very attractive economies. However, in general, and particularly in the US, the retail environment continues to be challenging, with slowing traffic. The company is undertaking a number of steps, including holiday campaigns, to continue the improvement of the business. Earlier in the year, the company had announced the closing down of 140 of its 675 North American stores, and the shedding of 250 corporate jobs by the end of the fiscal year (ended January).

Comps- Gap

Till date, while the changes have not helped the company to return to positive growth, there does seem to be some progress. Gap posted soft comparable store sales for the month of November. While this is somewhat disappointing, given the expected robust e-commerce growth from the Black Friday weekend, and a more favorable macro backdrop to consumer spending, the decline was the result of an unexpected fall in sales at Old Navy, the only division that had been performing well for the company, and the negative impact of the fire at its Fishkill distribution center in the summer. The retailer posted a 1% fall in same store sales in November, although this was better than the 8% drop in the same month last year. The company estimates a negative impact of three percentage points as a result of the fire at its distribution center. The company also stated that a majority of the fire-related impact in the fourth quarter occurred during the month, and hence in the rest of the quarter, the comps should not have such a heavy impact. By brand, comps fell 3% at Gap Global, and a positive 1% if the fire impact is excluded. At Old Navy, the metric slipped 2%, with a one percentage point impact from the fire. Banana Republic, which has been the weak link for the company in recent times, reversed its trend of posting negative comps with a 5% rise in November. Moreover, when compared with a 19% fall in the same month last year, the performance of the brand has been quite impressive. The growth in the brand was a result of a positive customer response to its latest product assortments.

Sabrina Simmons, chief financial officer at Gap Inc., stated that while November traffic trends were challenging, they improved as the month progressed. This is encouraging for the remainder of the quarter, with the company focused on executing its holiday plans. Given that the impact of the Fishkill fire will subside as the quarter wears on, the hopes of a turnaround may finally be in the cards. The company’s distribution center in Fishkill, New York primarily held Gap and Banana Republic products for distribution to stores, and fulfilled online orders for Gap and Old Navy in the Northeast region of the United States. As a result of it, the company has taken a number of steps to mitigate the overall impact to the business. This includes utilizing the company’s other distribution centers in North America, and rerouting the inbound freight, intended for the Fishkill distribution center, to others. Gap has also constructed a temporary fulfillment center at the Fishkill campus, which has begun processing orders.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Gap Inc.
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