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Gap's 1Q Earnings Beat, Maintains View

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Driven by robust top-line growth and improved margins, Gap Inc.’s (GPS - Free Report) earnings of 71 cents a share for the first quarter of fiscal 2013 soared 51.1% from the comparable prior-year quarter number of 47 cents. The company’s earnings benefited from a calendar shift due to 53 weeks in fiscal 2012 and favorable tax resolution, and were above the Zacks Consensus Estimate of 69 cents per share.

Gap’s net sales increased 6.9% year over year to $3,729 million, up from the previous-year quarter figure of $3,487 million and surpassed the Zacks Consensus Estimate of $3,707 million. Moreover, the company registered growth of 2% in its comps against a 4% rise in the comparable prior-year period.

The company’s first-quarter comps mainly benefited from the continued positive trend in its all global brands, which include Gap, Banana Republic, and Old Navy. During the quarter, comps at the company’s Gap Global and Old Navy Global increased 3% each, while comps at Banana Republic Global remained flat year over year.

Further, the company’s online business continues to post strong results with revenues rising approximately 26.6% to $509 million from $402 million in the year-ago comparable quarter. During the quarter, Gap’s online business contributed about 13.6% 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 last 4 trailing quarters.

Quarter in Detail

Quarterly gross profit surged 12.3% year over year to $1,544 million, while gross margin improved 200 basis points to 41.4%. The year-over-year increase in gross margin was primarily driven by improved merchandize margins due to lower average cost per unit and reduced rent and occupancy expenses as a percentage of sales.

Gap’s operating income for the quarter came in at $530 million, up 34.2% from the prior-year quarter figure of $395 million. Moreover, operating margin improved 290 bps to 14.2% due to an expansion in gross margin and lower operating expenses as a percentage of net sales.

Balance Sheet, Share Repurchases and Dividend

The company ended the quarter with cash and cash equivalents, and short-term investments of $1,610 million, compared with $2,047 million in the year-ago period. The company’s shareholder equity was $3,161 million.

Free cash flow was $205 million compared with $216 million in the last-year period. In the reported quarter, the company made a capital expenditure of $151 million and intends to expend $675 million in fiscal 2013. Moreover, Gap spent $58 million toward share buyback and $70 million toward dividend payment.

The company’s inventories were up 8.3%to $1,723 million in the quarter compared with the prior-year level. Inventory dollars per store at the end of first quarter increased 3%.

Store Count

In the first quarter, Gap opened 43 company-operated stores and shuttered 33 locations, bringing the total company-operated store count to 3,105. Moreover, in the same quarter, the company opened 11 franchised outlets, bringing the count to 323. This brings the company’s total store count as of May 4, 2013 to 3,428.

Fiscal 2013 Outlook

In fiscal 2013, Gap continues to expect earnings in the range of $2.52–$2.60 per share, increasing 8%–12% from fiscal 2012. Moreover, the company still anticipates operating margin to be approximately 13.0% in fiscal 2013, while depreciation and amortization as well as net of amortization of lease incentives will likely amount to $475 million.

Further, Gap anticipates an increase in inventory dollars per store in the mid single-digit range at the end of second-quarter fiscal 2013 on a year-over-year basis.

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. Store closures will include shutting Gap North American outlets, in sync with its previously announced strategy. In fiscal 2013, the company expects its net square footage to increase by 1%.

Other Stocks Worth Considering

Currently, Gap carries a Zacks Rank #2 (Buy). Other well performing stocks among apparel retailers include American Apparel, Inc. , Buckle Inc. (BKE - Free Report) and Zumiez Inc. , all of which have the same rank as Gap.

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