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Driven by robust top-line growth and improved margins, Gap Inc.’s (GPS - Analyst Report) earnings of 64 cents a share for the second quarter of fiscal 2013 soared 30.6% from 49 cents earned in the comparable prior-year quarter. Moreover, the company’s earnings came in line with the Zacks Consensus Estimate.

Gap’s net sales increased 8.2% year over year to $3,868 million, up from the previous-year quarter figure of $3,575 million and surpassed the Zacks Consensus Estimate of $3,834 million. Moreover, the company registered growth of 5% in its comparable-store sales (comps) against a 4% rise in the comparable prior-year period.

The company’s comps mainly benefited from the consistently rising sales in its Gap and Old Navy brands. During the quarter, comps at Gap Global and Old Navy Global increased 6% each, while comps at Banana Republic Global dropped 1%.

Further, the company’s online business continues to post strong results with revenues rising approximately 27.0% to $466 million from $367 million in the year-ago comparable quarter. During the quarter, Gap’s online business contributed about 12.0% to its total revenue.

We believe that the company’s consistent focus on turnaround strategies for improving the top line  is bearing fruit, as reflected in its solid comps and sales performances in the trailing 4 quarters.

Quarterly gross profit surged 9.8% year over year to $1,567 million, while gross margin improved 60 basis points (bps) to 40.5%. The year-over-year increase in gross margin was primarily driven by lower rent and occupancy expenses as a percentage of sales, partially offset by reduced merchandize margins.

In dollar terms, operating expenses increased $44 million year over year to $1,046 million. However, as a percentage of sales, it declined 100 bps to 27.0% from 28.0% in the comparable year-ago quarter.

Benefiting from improved gross margin and lower operating expenses as a percentage of sales, Gap’s operating margin expanded 160 bps to 13.5%. In dollar terms, operating income grew 22.6% year over year to $521 million.

Balance Sheet, Share Repurchases and Dividend

The company ended the quarter with cash and cash equivalents, and short-term investments of $1,925 million, compared with $2,114 million as of Jul 28, 2012. The company’s long-term debt and shareholder equity were $1,247 million and $3,458 million, respectively.

During the first six months of fiscal 2013, Gap generated a free cash flow of $542 million compared with $673 million as of Jul 28, 2012. In the first half of the fiscal, the company’s capital expenditure was $315 million and it intends to spend a total of $675 million in the fiscal year.

Furthermore, Gap has always been committed to creating value for its shareholders by returning capital in the form of dividends and share repurchase programs. Gap spent $85 million toward share buyback and $140 million toward dividend payment during the first two quarters of fiscal 2013.

Along with the earnings release, the company announced its intention to raise the annual dividend to 80 cents per share from 60 cents. Moreover, Gap revealed that its board of directors has authorized a dividend of 20 cents per share for the third quarter, which will be payable on Oct 30 to shareholders of record as of Oct 16. The company has raised its dividend tenfold from 2 cents per share in 2004 to the present amount of 20 cents. Moreover, Gap has returned over $14 billion to its shareholders through share repurchases and dividend payments during the same time period.

The company’s inventories were up 10.1% to $1,837 million in the quarter compared with the prior-year level. Inventory dollars per store at the quarter-end increased 6%. Further, Gap anticipates an increase in inventory dollars per store in the mid single-digit range at the end of third-quarter fiscal 2013 on a year-over-year basis.

Store Count

In the reported quarter, Gap opened 34 company-operated stores and shuttered 33 stores, bringing the total company-operated store count to 3,106. Moreover, in the same quarter, the company opened 15 franchised outlets, bringing the count to 338. This brings the company’s total store count as of Aug 3, 2013 to 3,444.

In fiscal 2013, the company intends to open 160 company-operated stores and close 80 existing stores. The company will be mainly focused on opening more Athleta, Gap China, Old Navy Japan, and global outlets. Regarding the shuttering of stores, Gap will be more inclined to close Gap North American outlets, in line with its previously announced strategy. In fiscal 2013, the company expects net square footage to increase by 1%.

Fiscal 2013 Outlook

Buoyed by the strong quarterly performance, Gap raised its fiscal 2013 earnings guidance range to $2.57–$2.65 per share from $2.52–$2.60 forecasted earlier. Moreover, the company continues to anticipate operating margin to be approximately 13.0% in fiscal 2013, while depreciation and amortization as well as net of amortization of lease incentives are projected to be $475 million.

Other Stocks Worth Considering

Currently, Gap carries a Zacks Rank #2 (Buy). Other well performing stocks among apparel retailers include Express Inc. (EXPR - Snapshot Report), Genesco Inc. (GCO - Snapshot Report) and L Brands, Inc. , all of which have the same Zacks rank as Gap.

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