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Driven by robust top-line growth and improved margins, Gap Inc.’s (GPS - Analyst Report) earnings of 72 cents per share for the third quarter of fiscal 2013 soared 14.3% from 63 cents earned in the comparable prior-year quarter. Moreover, the company’s earnings beat the Zacks Consensus Estimate by a penny.

Gap’s net sales increased 2.9% year over year to $3,976 million, up from the previous-year quarter figure of $3,864 million but marginally fell short of the Zacks Consensus Estimate of $3,978 million. Moreover, the company registered growth of 1% in its comparable-store sales (comps) against a 6% rise in the comparable prior-year period.

The company’s comps mainly benefited from the consistent rise in sales in the Gap Global brand. During the quarter, comps at Gap Global inched up 1% and Old Navy Global remained flat, while comps at Banana Republic Global dropped 1%.

Further, the company’s online business continues to post strong results with revenues rising approximately 20.0% to $589 million from $491 million in the year-ago comparable quarter. During the quarter, Gap’s online business contributed about 14.8% to its total revenue.

We believe that the company’s consistent focus on turnaround strategies for improving the top line  has been successful, given the solid comps and sales performances in the trailing 5 quarters.

Quarterly gross profit marginally fell to $1,589 million from $1,593 million in the year-ago comparable quarter, while gross margin contracted 120 basis points (bps) to 40.0%. The year-over-year decline in gross margin was primarily due to a fall of 140 bps in merchandize margins, partially offset by a 20 bps benefit from lower rent and occupancy expenses as a percentage of sales.

Due to the company’s continued efforts toward lowering costs, operating expenses decreased 5.6% year over year to $1,013 million. Consequently, as a percentage of sales, it improved 230 bps to 25.5% from 27.8% in the comparable year-ago quarter.

In dollar terms, operating income grew 10.8% year over year to $576 million while operating margin expanded 100 bps to 14.5%. The year-over-year increase in operating margin was primarily due to lower operating expenses as a percentage of sales, partially offset by decline in gross margin.

Balance Sheet, Share Repurchases and Dividend

The company ended the quarter with cash and cash equivalents, and short-term investments of $996 million, compared with $1,770 million as of Oct 27, 2012. The company’s long-term debt and shareholder equity were $1,247 million and $2,956 million, respectively.

During the first nine months of fiscal 2013, Gap generated a free cash flow of $466 million compared with $776 million as of Oct 27, 2012. In the first three quarters of the fiscal, the company’s capital expenditure was $487 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 $875 million toward share buyback and $232 million toward dividend payment during the first three quarters of fiscal 2013.

On Nov 13, Gap announced that its board of directors has authorized a dividend of 20 cents per share for the fourth quarter, which will be payable on Jan 29, 2014 to shareholders of record as of Jan 8, 2014. The company has raised its dividend tenfold from 2 cents per share in 2004 to the present amount of 20 cents.

The company’s inventories were up 8.9% to $2,471 million in the quarter from the prior-year level. Inventory dollars per store at the quarter-end increased 4%. Further, Gap anticipates an increase in inventory dollars per store at the end of the final quarter, which will be higher than the third-quarter increase, but will remain in single digits.

Store Count

In the reported quarter, Gap opened 65 company-operated stores and shuttered 11 stores, bringing the total company-operated store count to 3,160. Moreover, in the same quarter, the company opened 20 franchised outlets and closed 3 outlets, bringing the count to 355. This brings the company’s total store count as of Nov 2, 2013 to 3,515.

In fiscal 2013, the company intends to open 160 company-operated stores and close 80 existing stores. Gap will focus on opening more Athleta, Gap China, Old Navy Japan, and global outlets. With regard to store closures, 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 Reaffirmed

The company has reiterated its fiscal 2013 earnings guidance range of $2.57 to $2.65 per share. 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 #3 (Hold). Some better-ranked stocks in the same sector include DSW Inc. (DSW - Snapshot Report), Finish Line Inc. (FINL - Snapshot Report) and Fossil Group, Inc. (FOSL - Analyst Report). All these hold a Zacks Rank #2 (Buy).

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