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Gap (GPS) Dips Despite Lower-Than-Expected Q2 Loss, Sales Beat

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The Gap Inc. (GPS - Free Report) reported narrower-than-expected loss per share in second-quarter fiscal 2020, while sales beat the Zacks Consensus Estimate. However, sales declined on a year-over-year basis. Results continued to be impacted by the temporary closure of stores during the quarter, which led to a loss of sales and a lower merchandise margin. Nevertheless, the company witnessed strong online demand and leveraged its omni-channel capabilities to fulfill online orders and serve customers. This resulted in robust online sales growth in the fiscal second quarter, which mostly offset the decline in in-store sales.

However, driven by the prevailing uncertainty, the company did not currently provide guidance for fiscal 2020.

Shares of Gap declined 1.6% in the after-hours trading session on Aug 27. In the past three months, shares of the Zacks Rank #3 (Hold) company have gained 95.3% compared with the industry’s 34.9% growth.

 

 

Q2 Highlights

In the fiscal second quarter, the company’s loss of 5 cents per share was narrower than the Zacks Consensus Estimate of a loss of 37 cents, whereas it recorded earnings per share of 44 cents in the year-ago quarter.

Net sales declined 18.2% year over year to $3,275 million but surpassed the Zacks Consensus Estimate of $3,119 million. Sales were significantly hurt by the coronavirus outbreak-led store closures. Notably, it witnessed a 48% decline in store stores due to the partial closure of stores throughout the reported quarter.

Further, the quarter marked the reopening of the stores that were closed due to the COVID-19 outbreak, which was initiated in May. Notably, the company had nearly 90% of its global store fleet operational by Aug 1.

The Gap, Inc. Price, Consensus and EPS Surprise

 

The Gap, Inc. Price, Consensus and EPS Surprise

The Gap, Inc. price-consensus-eps-surprise-chart | The Gap, Inc. Quote

On the other hand, the company continued to put up a great show in its e-commerce channel, with 95% growth in online sales during the fiscal second quarter. This majorly contributed to strong comparable store sales (comps) growth during the quarter. Notably, its e-commerce business added more than 3.5 million new customers in the fiscal second quarter. This represented more than 165% growth in new online customer acquisition year over year.

Driven by the robust e-commerce show and comps growth at stores that reopened, the company delivered positive comps of 13% in the quarter. Brand-wise, comps improved 24%, 12% and 19% at Old Navy Global, Gap Global and Athleta, respectively. However, comps for the Banana Republic Global were down 27%. The Banana Republic brand’s product mix was unfavorable due to the sudden shift of consumers’ demand to more casual fashion to meet stay-at-home requirements, which served as a disadvantage to the brand’s work wear assortments. However, the company is focused on adjusting to consumer preferences and improving inventory mix.

Brand-wise, net sales were down 5%, 28% and 52% at Old Navy Global, Gap Global and Banana Republic Global brands, respectively. Meanwhile, sales improved 6% for the Athleta brand. The company witnessed significant declines in in-store sales for all formats, with Old Navy down 36%, Gap down 55%, Banana Republic down 71% and Athleta down 45%. Meanwhile, there was a significant acceleration in the digital business for all brands, recording increases of 136%, 75%, 26% and 74%, respectively, for Old Navy, Gap, Banana Republic and Athleta brands.

For the Gap brand, the company benefited from the brand’s fleet rationalization efforts, focused on maximizing online demand through relevant marketing, improved execution and customer engagement. Moreover, the Old Navy brand gained from the significant acceleration of online business due to robust customer demand as well as relevant digital marketing investments. The Athleta brand’s values-driven active and lifestyle categories as well as strong omni-channel presence boosted growth.

Margins

Gross profit in the quarter under review was $1,149 million, reflecting a 26.2% decline from $1,556 million in the prior-year quarter. Gross margin of 35.1% declined 380 basis points (bps) from the prior-year quarter. Most of the decline was attributed to a rise in shipping expenses to fulfill the higher online orders and the company’s decision to leverage its stores to fulfill online demand, which led to a deleverage in merchandise margin. Further, higher rent and occupancy costs relative to the lost sales on store closures hurt gross margin, which was partly negated by reduced promotions at Old Navy, Gap and Athleta.

Meanwhile, operating expenses declined 15.5% to $1,076 million on lower store payroll and benefits cost and other store expenses stemming from the closure of stores in the quarter. However, operating expense rate increased 110 bps to 32.9%.

Driven by the fall in gross margin and a rise in operating expense rate, the company reported operating margin of 2.2%, down 480 bps from the year-ago quarter. Operating income declined 74.1% year over year to $73 million in the reported quarter.

Financials

Gap ended the fiscal second quarter with cash and cash equivalents of $2,188 million, representing more than $1 billion growth on a year-over-year basis. As of Aug 1, it had total stockholders’ equity of $2,253 million and long-term debt of $2,212 million.

In the fiscal second quarter, the company issued $2,250 million worth of senior secured notes. The proceeds from this issue were used to pay down $1,250 million of senior notes due April 2021. It also secured a $1,868 million of asset-based revolving credit facility, which replaced the existing $500-million unsecured revolving credit facility. As of Aug 27, there have been no borrowings under the $1,868-million facility and the company does not expect to access the facility in fiscal 2020.

Consequently, as of Aug 27, it had $1,868 million available for use. The new capital provides sufficient liquidity to steer clear from the coronavirus environment.

The company expects capital spending of $300 million for fiscal 2020, including $30 million of expansion costs related to its Ohio distribution center.

Store Update

As on Aug 1, Gap had 3,814 stores in 42 countries, out of which 3,215 were company-operated and 599 were franchise outlets.

Going forward, the company plans to close more than 225 Gap and Banana Republic stores globally, net of openings, in fiscal 2020. This is in sync with the company’s ongoing fleet optimization efforts to further advance its long-term strategic priority of a smaller healthier fleet. It expects additional closures in fiscal 2021.

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