Can Gap Inc. Deliver A Beat In Its Second Quarter?

by Trefis Team
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Gap Inc.
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The apparel retail industry has been plagued with soft mall traffic and reduced consumer spending, which has resulted in a spate of downsizing and bankruptcies. Gap Inc. (NYSE:GPS), being a part of this blighted sector, has been suffering as a result. However, in its first quarter earnings release, it reported an improvement in its earnings per share and a largely flat sales growth, both metrics which beat consensus estimates, bucking the trend of dismal results in the retail industry. Improved sales also resulted in an uptick in the operating margins.

However, this time around, a 2% fall in revenues is expected. Weak sales in the past had forced the company to resort to markdowns, which consequently pressured margins. Could the company fall back into that vicious cycle if the sales remain low? That is the biggest question facing the company this earnings season, in a highly pivotal quarter.

Significant Changes May Help In The Turnaround

The company has undertaken a number of changes to turn the corner, some significant, and others quick fixes. These include addressing the quality, aesthetic, the value, and the fit, in order to improve the product lines. Among the moves that required a lot of work, the most noteworthy has been the work on the lead time. According to CEO Peck, the average development cycle for the industry has been 10 months. Gap has done the work to bring it down for many of its programs and categories to 8 to 10 weeks, with one-third of its products having the capability to be produced within the quarter. This will enable the company to better compete with fast fashion retailers, such as H&M and Zara, who are known for their quick turn-around times.

This factor has also ensured that the company can manage the inventory more efficiently. An example of this is that the company can now keep more fabric at hand, platforming approximately 60% of the fabric needs, which permits them to cut and sew garments immediately at the release of a purchase order. The company has also increased the testing of the product, through either crowd-sourcing or physically testing the product in the stores, to be better informed about the buying commitments. Particularly in the Gap brand, the company has moved to a demand-based buying model, with one platform across all inventory, pricing, assortment building, and in-season management. This same program is set to be implemented across the whole company. This not only helps to bring the right product to the right place at the right time, but also helps the cost structure.

Gap is also focused on delivering an improved digital experience to its customers, as well as one in-store. Taking advantage of a shift in traffic towards mobile, the company has launched its native mobile apps, starting with Old Navy, and customer feedback points to an improved experience over the web-based app, provided earlier.

Old Navy To Lead Sales Growth

Old Navy has been Gap’s only well-performing segment, and has been a lifeboat for the company in the many distressing quarters it has faced in the recent past. The brand continued its strong showing in the first quarter as well. While tough traffic trends existed during the quarter, the company managed to overcome that with the help of a strong commercial plan, impressive marketing, and better product acceptance. The brand, being more pocket-friendly than Gap’s other brands, has been the one driving the company’s sales growth, and Gap intends to continue investing in it and building that business. The brand’s positioning in the value-segment, with an off-mall presence, has resulted in incremental tailwinds.

However, the other two brands of the company have not seen much of an improvement in their performance, and again delivered negative comparable sales in the first quarter. While a number of initiatives have been implemented by the company to turn around these two businesses, no positives are forthcoming as yet. Although improvements are not expected to show over night, the soft retail environment will not make matters any easier, and it might just delay the improvement in the performance. While the progress at Gap has been slower than expected, there have been some improvements in key places in the business. However, Banana Republic’s performance has been plaguing the company. Many consumers are not willing to pay the higher price points charged by the brand. Steps such as reducing the store count or even shuttering of the business may make more sense for the company.

See our complete analysis for Gap Inc.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such 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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