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Gap (GPS) to Gain on Brand Strength & Online Demand in 2021

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The Gap, Inc. (GPS - Free Report) has been gaining from robust online momentum and solid performance in its powerhouse brand — Old Navy — as well as smaller brands, such as Athleta. This led to sequential growth in third-quarter fiscal 2020 results, with positive comparable sales (comps). Further, continued growth in the e-commerce business contributed significantly to the company’s consolidated sales as well as gains from its Gap, Old Navy and Athleta brands.

Notably, the online business contributed about 40% of its net sales in the fiscal third quarter. Its e-commerce business acquired 3.4 million new customers in the fiscal third quarter, which represents more than 145% growth in new online customer acquisitions year over year. Consequently, e-commerce sales improved 61% in the reported quarter. Also, the company’s strong online business aided comps growth in the quarter. Notably, comps improved 5% and online sales rose 61% in the said quarter.

Management remains optimistic about fourth-quarter fiscal 2020 results (ending January 2021). The company’s increased investments in digital capabilities, including curbside pickup options, and its loyalty program are likely to have contributed to a robust holiday shopping season. As a result, it earlier expected fourth-quarter fiscal 2020 net sales to be equal to or slightly higher than the year-ago quarter. Gross margin was forecasted to be flat year over year on gains from store closures, considerably offset by higher shipping expenses.

Moreover, the company remains poised to gain from its Old Navy brand, which has been witnessing a significant acceleration in the digital business since the start of the pandemic, on the back of robust customer demand. Net sales for the Old Navy brand improved 15% in the fiscal third quarter, with comps growth of 17%.

Further, its smaller brands, namely Athleta, act as key growth drivers. Notably, the Athleta brand’s value-driven active and lifestyle categories, increased digital marketing investments, and focus on product strategy have been aiding sales. In third-quarter fiscal 2020, Athleta’s net sales were up 35%, with comps growth of 37%. Notably, Athleta recorded the highest comps growth in the brand’s history during the quarter, including more than 50% contribution from the online business. The brand also benefited from continued demand for its masks, which helped establish new customer engagements across other product offerings. In addition to these, both brands cumulatively accounted for 63% of sales in third-quarter fiscal 2020.

Apart from these, it remains on track with the execution of its Power Plan 2023, which focuses on opening highly-profitable Old Navy and Athleta stores. As part of the plan, the company expects the Old Navy and Athleta brands to contribute about 70% of sales by 2023. In sync with its fleet optimization efforts, the closing of underperforming Gap and Banana Republic stores is anticipated to realize $100 million in EBITDA savings annually by the end of 2023. It also envisions the e-commerce business to contribute 50% of sales by the end of 2023 on the back of higher investments in digital, technology and distribution capacity.

Hurdles to Overcome

That said, all is not well with Gap. The company continues to reel under sluggish store traffic due to rising COVID-19 cases. Further, the shift in consumers’ demands to more casual fashion in a bid to meet stay-at-home requirements is weighing on Gap’s Global and Banana Republic Global brands, which specialize in workwear assortments. As a result, management decided to shut down a few underperforming stores, which is likely to be executed in fiscal 2021.

Also, higher operating expenses, driven by elevated spending toward health and safety measures at stores, and a significant rise in marketing expenses across all brands act as headwinds. Moreover, higher shipping expenses to fulfill the increased online orders are concerning. The company expects an operating expense rate of 33-34% in fourth-quarter fiscal 2020.  

However, we believe that a solid online show and strength in its Old Navy and Athleta brands will provide some cushion to the Gap stock, which has underperformed the industry in a year’s time. Notably, shares of this Zacks Rank #3 (Hold) company have rallied 19.1% compared with the industry’s growth of 46.8%.

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