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Driven by increased sales along with improved margins and a lower share count, Gap Inc.’s (GPS - Analyst Report) earnings of 49 cents per share for the second quarter of fiscal 2012 beat the Zacks Consensus Estimate by a penny. The earnings also climbed 40% from the last quarter’s earnings of 35 cents.
Quarter in Detail
During second-quarter, Gap’s net sales increased 5.6% year over year to $3,575 million from $3,386 million in the previous-year quarter. Moreover, the company registered a growth of 4% in its comps against a 2% decline in the prior-year period. Further, quarterly sales were in line with the Zacks Consensus Estimate.
The company’s second-quarter comps mainly benefited from the continued positive trend in its North American business. During the quarter, comps at the company’s Gap North America, Banana Republic North America and Old Navy North America improved 7%, 7% and 3%, respectively. Whereas, the company’s International business comps declined 5% year over year.
Quarterly gross profit jumped 14.1% year over year to $1,427 million, primarily due to lower input costs. Consequently, gross margin expanded 300 basis points (bps) to 39.9%.
Gap’s operating income for the quarter came at $425 million, up from the prior-year quarter operating income of $334 million. Moreover, operating margin expanded 200 bps to 11.9% due to an expansion in gross margin. Operating expenses increased $85 million from the previous-year quarter due to increased marketing expenses for promoting Gap brand and enhancing customer relationships.
Moreover, with efficient inventory management, the company’s inventories were down 6% from the prior-year quarter level. Further, Gap is expecting inventory levels to decline in the low single-digit range at the end of the third quarter of fiscal 2012 on a year-over-year basis.
Balance Sheet, Share Repurchases and Dividend
At the end of the second quarter of fiscal 2012, the company has cash and cash equivalents and short-term investments of $2,114 million compared with $2,179 million in the year-ago period. Besides, free cash flow during the first six months of fiscal 2012 was $673 million compared with $298 million in the previous-year quarter. The company’s shareholders equity was $2,898 million. Gap’s total number of outstanding shares declined about 12.1% to 479 million from 545 million reported in the prior-year quarter.
During the six month period, the company has made a capital expenditure of $297 million and expects to expend $675 million in fiscal 2012. During the quarter, the company deployed $349 million of cash toward share buybacks.
In the quarter, Gap paid a quarterly dividend of 12.5 cents per share, an increase of 11% from the prior-year quarter.
In the second quarter, Gap opened 29 company-operated stores and shuttered 20 locations, bringing the total company-operated store counts to 3,035. Moreover, in the same quarter, the company opened 8 stores and closed 2 stores in franchise business, bringing the total franchise store counts to 250.
In an effort to improve customer experience and boost productivity per square footage, the company plans to strategically close and consolidate square footage at Gap and Old Navy brands. In 2012, Gap intends to net open 15 company-operated stores and 50 – 75 franchise stores in different locations. Moreover, it also expects to decrease net square footage by 1% in fiscal 2012. In the second quarter, the company’s net square footage decreased 2% to 36.8 million from 37.7 million in the previous-year quarter.
Fiscal 2012 Earnings Outlook Up
Better-than-expected quarterly performance has prompted management to raise its fiscal 2012 earnings guidance. The company now expects earnings in the range of $1.95 - $2.00 per share for fiscal 2012, an increase of 25% to 28.2% from fiscal 2011. Earlier, Gap was expecting earnings in the range of $1.78 - $1.83 per share for fiscal 2012, an increase of 14% to 17% from fiscal 2011. The current Zacks Consensus Estimate stands at $2.08 per share, above the company’s new guidance range. Moreover, Gap is now anticipating an increase of 11% in operating margin during fiscal 2012, up from previous guidance of 10%.
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 the company to drive value proposition. Moreover, Gap’s globally recognized brands complement each other, enabling it to leverage its position in the sector.
Further, in order to boost the international operations, Gap consolidated its foreign business under one division from London. Lackluster sales in North America compelled the company to explore business in other regions. To counter the domestic market saturation, Gap is aiming to generate 30% of total sales from its overseas operations and online business by 2013. For this, Gap has opened stores in China, Italy and Australia and has launched an e-commerce business in more than 90 markets. These initiatives are expected to bolster the company’s top- and bottom-line performance, moving forward.
However, Gap operates in a highly fragmented market and competes with national and local department stores and discount stores, such as American Eagle Outfitters Inc. (AEO - Analyst Report) and The TJX Companies Inc. (TJX - Analyst Report), which offer products at fire sale prices. To retain the existing market share, the company may have to slash sales prices, which could affect its margins.
Gap’s shares carry a Zacks #1 Rank, which translates into a short-term Strong Buy rating. However, our long-term recommendation on the stock remains ‘Neutral’.