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Based on better-than-expected quarterly performance and increased outlook for fiscal 2012, we have upgraded our long-term recommendation on Gap Inc. (GPS - Analyst Report) to ‘Outperform’ from ‘Neutral’. Moreover, the company maintains a Zacks #1 Rank implying a short-term Strong Buy rating on the stock.

The company’s lately reported earnings of 49 cents per share for the second quarter of fiscal 2012 climbing 40% from the prior-year earnings of 35 cents and beating the Zacks Consensus Estimate by a penny. The year-over-year improved results were primarily driven by increased sales, better margins and lower share counts. Moreover, driven by 4% growth in comparable-store sales, Gap’s revenue for the quarter increased 5.6% year over year to $3,575 million.

Buoyed by strong quarterly performance, management raised its fiscal 2012 earnings guidance range to $1.95–$2.00 per share from $1.78–$1.83 forecasted earlier. Moreover, Gap now anticipates an increase of 11% in operating margin during fiscal 2012, up from the previous guidance of 10%.

The company’s relentless efforts to return to the growth curve seem to be paying off, as evidenced by the solid comps and sales performance in recent months. During the period from February to August, the company registered improvements in comparable sales in each month, except April. During that period, comps growth touched a low of negative 2% and a high of 10%, thereby recording average growth of approximately 4%. In the first seven months of fiscal 2012, comps increased 4% in February, 8% in March, 2% in May, flat in June, 10% in July and 9% in August while it declined 2% in April.

Monthly sales data for Gap also showed a decent performance. Within February to August 2012, the company registered a minimum year-over-year flat sales growth and a maximum growth of 12%, reflecting an average growth of approximately 6% for the period. The company registered sales growth of 6% in February, 10% in March, flat in April, 4% in May, 2.2% in June, 12% in July and 9% in August.

We believe that Gap’s long-term strategic moves, along with disciplined cost management measures will not only provide financial flexibility to the company, but also help it drive value proposition. Moreover, Gap’s globally recognized brands complement each other, enabling it to leverage its position in the sector.

Gap’s net revenue was $14.5 billion in the fiscal 2011. The company mainly 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.

Founded in 1969 and headquartered in San Francisco, Gap is a leading retailer that operates Gap, Banana Republic, Old Navy, Piperlime and Athleta brands. The offerings of the company's core brands include clothing, accessories as well as personal care products for men, women and kids. Gap operates in 90 countries through a pipeline of 3,000 company-operated stores, 250 franchise stores and e-commerce sites.

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