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Note: More details to come; changes are highlighted. Except where highlighted, no other sections of this report have been updated.
Reason for Report: FLASH UPDATE: 3Q17 Earnings Release
Prev. Ed.: Nov 15, 2017; 2Q17 Earnings Update
Flash Update [Earnings update in progress; to follow]
On November 16, 2017, Gap Inc. released its third-quarter fiscal 2017 results. This was the company’s third straight quarter of positive earnings surprise while it recorded sixth consecutive sales beat. Also, comparable store sales (comps) reflected strength for the fourth quarter owing to continued momentum at key areas of the company’s business.
However, foreign currency adversely impacted the company’s bottom line, which declined on a year-over-year basis.
Q3 Highlights
Gap’s adjusted earnings of 58 cents per share in the fiscal third quarter surpassed the Zacks Consensus Estimate of 55 cents. However, the bottom line declined 3.3% from 60 cents earned in the year-ago period. Currency dented earnings per share growth by about 3 percentage points. Also, on a GAAP basis, earnings came in at 58 cents compared with 51 cents in the prior-year period.
Net sales grew 1.1% to $3,838 million and also fared better than the Zacks Consensus Estimate of $3,774 million. The upside was backed by comps growth of 3%, as against a 1% decline in the year-ago period.
Meanwhile, comps continued to gain from robust Old Navy performance that was fueled by improved traffic. Also, the company’s namesake brand witnessed comps growth, which aided results. These were partly offset by persistent softness across Banana Republic. Looking at numbers, Old Navy and Gap comps grew 4% and 1%, respectively, as against Banana Republic’s comps decline of 1%.
Margins
Gross profit rose 2.1% to $1,525 million with the gross margin expanding 40 basis points (bps) to 39.7%. Adjusted gross margin grew 60 bps, mainly owing to rent and occupancy leverage of 60 bps backed by comps growth. The figure was offset by flat merchandise margins.
Operating income fell 2.8% to $378 million with operating margin contracting 40 bps to 9.8%. Also, the adjusted operating margin contracted 120 bps due to higher adjusted operating expenses. These expenses stemmed from greater marketing as well as payroll costs, along with investments in digital and customer service initiatives.
Financials
Gap ended the quarter with cash and cash equivalents of $1,353 million, long-term debt of $1,248 million, and total stockholders’ equity of $3,024 million.
During the nine months of the current year, the company generated cash flow from operations of $600 million and incurred capital expenditures of $463 million. Gap had free cash flow of $197 million as of Oct 28, 2017.
For fiscal 2017, management continues to project capital expenditure of roughly $625 million, excluding the planned $175 million spending associated with reconstructing the Fishkill, New York distribution center campus and related supply chain costs.
Coming to Gap’s shareholder-friendly moves, the company paid a dividend of 23 cents per share in the reported quarter and bought back 3.8 million shares for approximately $100 million. Year to date, the company paid $272 million as dividend. Additionally, the company declared fourth-quarter dividend of 23 cents per share on Nov 9. Going forward, management plans to make buybacks worth roughly $100 million in the impending quarter.
Store Updates
In the third quarter, Gap introduced 50 stores while it shuttered 53 stores. Of these 50 stores, 41 were company-operated and nine were franchise. Similarly, the stores that were closed included 27 company-operated and 26 franchise stores. Consequently, the company ended the quarter with 3,639 outlets in 46 countries, of which, 3,193 were company-operated and 446 were franchise.
Gap now anticipates closures of nearly 30 company-operated stores, net of openings as well as repositions in fiscal 2017.
Outlook
Management remains impressed with the success against its balanced growth strategy that was announced in September. In this regard, Gap remains focused on enhancing product categories, boosting its web and mobile offerings and enhancing its footprint in the value and active space.
Backed by these initiatives and a solid performance in the nine months of fiscal 2017, management raised its outlook for the year.
Currently, Gap envisions adjusted earnings for the fiscal year in the range of $2.08-$2.12 per share compared with $2.02-$2.10, projected earlier. Further, comps are anticipated to be up low-single-digits versus earlier projection of flat to marginal improvement.
For the next quarter, management expects SG&A expenses to grow at the same pace as it has increased year to date.
MORE DETAILS WILL COME IN THE IMMIMENT EDITIONS OF ZACKS RD REPORTS ON GPS.
Portfolio Manager Executive Summary [Note: only highlighted material has been changed]
Based in California, The Gap, Inc. (GPS) is a clothing retailer operating approximately 3,300 retail company-owned stores under distinct apparel brand names – Gap, Old Navy, Banana Republic, Piperlime, Athleta, and Intermix brands. While most of these stores are in the U.S., Gap also has an overseas presence in the U.K., Canada, France, and Japan.
Of the 17 firms covering the stock, three provided a positive rating, 11 assigned a neutral rating, while four three rendered a negative rating.
Neutral or equivalent outlook (64.8%; 11/17 firms): These firms believe that Gap possesses several positives, i.e. a sound balance sheet, disciplined inventory management, ROIC focus, returns to shareholders via dividends or share repurchases, compelling expense control culture and scope for margin expansion in the long term. The sound balance sheet position is attributed to tight expense and inventory control, as well as prudent management of capital, facilitating the company to decide on the right time to enact a turnaround.
Though the neutral firms hold a favorable outlook about the company’s growth based on its supply chain initiatives, omni-channel developments and constant share repurchases, the ongoing currency headwinds make them cautious of Gap’s near-term performance.
Further, some neutral firms appreciate the restructuring initiatives undertaken by the company and believe that these adjustments will help place it in a better position. However, these firms believe that there are structural issues associated with the company. Although the firms think that it is possible to overcome such issues, it will take time until significant improvement is seen across all the divisions. Moreover, the firms remain skeptical, given the destabilized consumer environment along with increasing competition. Nonetheless, some neutral firms commend Gap’s marketing endeavors, which is likely to attract customers amid a tough macroeconomic environment with stiff competition.
These firms identified the company’s potential to grow its international business and believe that there are enough possibilities for franchise and online growth on the back of new store openings for Gap. However, firms are worried about the company’s store concept, given the rapid shift toward online shopping. Also, continued softness across Banana Republic remains a concern.
Positive or equivalent outlook (17.6%; 3/17 firms): Gap is adopting a balanced approach to reinvigorate its brands, while focusing on controlling inventories and maximizing gross profits. With reduced average unit cost and the implicit increase in initial merchandise margins, coupled with lean inventory, management at Gap has pricing flexibility, the ability to market, promote, and if necessary, use reduced prices to drive sales.
The firms believe that the Old Navy brand’s strong and continually improving value proposition will take the company forward. The firms also think that the Gap Global brand is on the road to recovery and will turn around once the product missteps are corrected. Also, these firms believe that in spite of foreign currency headwinds, the company has growth potential, given its altered leadership; efficient supply chain and omni-channel moves; latest product assortment; marketing initiatives and a solid balance sheet.
The firms commend the company’s initiatives in structuring units at all three core brands to efficiently compete for market share, which so far have been working well for it. Firms are impressed with Old Navy’s off-the-mall sales that are expected to continue to drive results. Also, firms anticipate witnessing some stability at the company’s namesake brand, if some of Old Navy’s strategies are applied to it. These firms also expect that the company’s growth initiatives will likely help it to gain market share, improve the Gap brand’s production and also Athleta brand will expand at a faster pace. Further, the company’s global performance will be enhanced, resulting in square foot expansion.
July 26, 2017
Overview [Note: only highlighted material has been changed]
The firms identified the following factors for evaluating the investment merits of the company:
Key Positive Arguments / Key Negative Arguments· Gap has been making significant progress in its long-term development plan by reducing dependence on the North American specialty business while increasing its online presence and expanding international operations.
· Gap witnessed considerable recovery in its comparable sales and total sales performance, driven by its consistent endeavors to remain buoyed on the growth trajectory.
· Gap’s healthy balance sheet and strong cash flow generation provide a solid foundation to withstand the current economic climate.
· The restructuring initiatives undertaken by Gap to better position its brand are expected to stabilize its segments once the product missteps are corrected. / · The current macroeconomic environment continues to weigh on consumer confidence, reducing mall traffic and overall shopper spending.
· Gap is aggressively focused on expanding its international operations; however, foreign currency headwinds pose challenges.
· The company believes that with the weakening of the credit market, financial results might be affected unfavorably.
· The firms believe that seasonality due to dependence on the holiday season, competition from departmental stores and general merchandisers, and currency, economic and regulatory risks pertaining to international operations are additional hazards for Gap.
CA-based Gap Inc. is a leading international specialty retailer offering clothing, accessories, and personal care products for men, women, children and babies through six brands – Gap, Banana Republic, Old Navy, Piperlime, Athleta and Intermix. Under the core Gap brand, the company operates Gap, GapKids, babyGap, GapMaternity, GapBody and GapFit. The company also operates Gap Outlet and Banana Republic Factory Outlet stores. The company operates online through www.gap.com, www.gapkids.com, www.babygap.com, www.bananarepublic.com, www.intermixonline.com , www.athleta.com and www.oldnavy.com.
Almost three-fourth of Gap’s revenue is derived from its U.S. operations. The company reports its operating results under four segments: Gap Global, Old Navy Global, Banana Republic Global and Others.
Ø Gap Global: This segment reports the operating results of all stores, including company-owned, franchise and online stores for the Gap brand, both domestic and international.
Ø Old Navy Global: This segment reports the operating results of all stores, including company-owned, franchise and online stores for the Old Navy brand, both domestic and international.
Ø Banana Republic Global: This segment reports the operating results of all stores, including company-owned, franchise and online stores for the Banana Republic brand, both domestic and international.
Ø Others: The relatively newer brands, namely Athleta and Intermix come under this segment. These brands are managed by the president of the Growth, Innovation, and Digital (GID) division, who oversees the store and online operations.
As of Jun 29, 2017, Gap operated 3,650 stores across over 90 countries, including 3,200 company-operated stores and nearly 450 franchise stores. The company also sells products via its eCommerce sites. Additional information is available at Gap’s website, www.gapinc.com. Gap’s fiscal year ends in January.
July 26, 2017
Long-Term Growth [Note: only highlighted material has been changed]
Gap is one of the most well-known and dominant global specialty apparel retailers, selling casual apparel, personal care, and accessories for men, women, children and infants. It has presented the best defense play in retail in terms of managing its inventory and expenses, and maximizing free cash flow.
The firms believe Gap’s long-term strategic moves, along with disciplined cost management measures, will not only provide financial flexibility, but also help to drive value proposition. Moreover, Gap’s globally recognized brands complement each other, enabling it to leverage its position in the sector.
Over the years, Gap has been focused on making improvements in its merchandise mix to win back customers. Looking ahead, the company expects to continue its practice of tight inventory management and better product assortment, which should ultimately lower the need to mark down new products as quickly as at present. This should consequently help margins to expand in the long run. Gap’s management is clear about its long-term plans. It does not intend to curtail selling, general, and administrative (SG&A) expenses at the cost of the company’s short or long-term business, at any point.
Moreover, Gap plans to continue making investments to develop omni-channel networks, prepare the company for supply chain management and for seamless inventories. In order to deal with the changing shopping habits and drive traffic, Gap continues to enhance its online capabilities and develop the omni-channel platform, through Ship-from-store, Find-in-store and Reserve-in-store capabilities. The company’s digital endeavors were also testified by its recently introduced “DressingRoom by Gap” app. In an earlier development, the company collaborated with leading popular European fashion e-Commerce site, Zalando, which marked Gap’s entry into Europe’s multi-brand retailing. All these efforts are likely to attract more customers and augment top line.
Some firms also believe that the company is aiming to bring about steady growth in productivity – directly, domestically and globally – through improved merchandise and lower per square footage. Further, the firms believe that Gap envisions prominent opportunities in the international markets as it plans to enter them with a multi-network strategy along with operating its efficient branches in more complicated and/or smaller areas.
Further, Gap’s initiatives to bolster its performance by re-positioning its brand image bodes well. In this regard, the company remains focused on growing its brands in regions which offer greater structural advantage and potential to expand market share. As part of this, management is committed toward growing its Old Navy brand in the most favorable markets, alongside closing down the underperforming stores. Also, the company remains keen on streamlining its operating model by creating a more proficient global brand structure. With these efforts underway, Gap remains committed to positioning itself better for long-term growth by setting its priorities right and channelizing its resources accordingly.