We maintain our long-term Neutral recommendation on Gap Inc. (GPS - Analyst Report) based on the company’s progress on its strategic plan, counteracted by the strained earnings performance throughout 2011.
Gap is one of the leading players in the highly fragmented specialty retail sector, offering a diverse range of clothing, accessories and personal care products for men, women, children and babies. Its flagship brands include Gap, Banana Republic, Old Navy, Piperlime and Athleta. The company’s globally recognized brands complement one another, enabling it to leverage its position in the sector.
In 2011, the company made significant progress on its strategic plan focused on reducing dependency on North American specialty business while increasing its online presence as well as expanding its international operations.
During the year, the company consolidated on the domestic front with 65 store closures and expanded its online presence by opening 8 Athleta stores. Further, the company expanded overseas with operations in 39 countries in 2011, against having operations in 31 countries at fiscal year-end 2010.
In an effort to improve customer experience and enhance productivity per square footage, the company intends to strategically close and consolidate square footage at Gap and Old Navy brands. Gap plans to strategically reduce its Gap North America store counts to 950 by the end of fiscal 2013, including 700 specialty stores and approximately 250 outlets.
Contrary to this, the company continues to aggressively expand internationally through both company-operated and franchise stores. Gap intends to triple its store count in China from 15 to approximately 45 during fiscal 2012. Additionally, the company targets to grow its Athleta stores count 5 times from 10 to 50 by end of fiscal 2013.
Additionally, Gap has established a track record of conservative capital management while maintaining a strong balance sheet. The company also generates strong free cash flow, allowing it to grow earnings per share through large stock repurchases and further increasing shareholder value by consistently raising its dividend.
During 2011, the company returned cash in excess of $2.3 billion to shareholders in the form of share repurchases and dividends. The company also announced a new $1 billion share repurchase authorization that replaces its previous $500 million authorization, which had about $441 million remaining as of February 23, 2012. The company also raised its annual dividend by 11.1% to 50 cents a share, currently yielding 2.0%.
However, we note that the company’s earnings results over the past year have been strained due to sluggish comparable store results and lower margins. In the fourth quarter, the company posted earnings per share of 44 cents, representing a 27% dip from the year-ago earnings.
A drop of 4% in comparable store sales mainly contributed to the earnings decline. Despite operating expense leverage, operating margins in the quarter contracted 490 basis points.
The company faced a number of challenges during the busiest shopping season of the year. Lackluster sales in North America have continuously dragged down Gap’s comparable store sales throughout fiscal 2011. The holiday season did not help the company to inflate its sales figures in December 2011.
Moreover, macroeconomic headwinds, intense competition and seasonal nature of the business remain matters of concern.
Gap is losing its market share against its rivals, such as The TJX Companies Inc. (TJX - Analyst Report) and Macy’s Inc. (M - Analyst Report). Both these companies successfully lured the shoppers with their aggressive promotional activities during the 2011 holiday season.
Currently, Gap’s shares maintain a Zacks #2 Rank, which translates into a short-term Buy rating. We believe that the company’s long-term strategic moves along with disciplined cost management measures will not only provide financial flexibility, but will also help to drive value proposition.