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Gap (GPS) Rises on Q2 Earnings & Sales Beat, Hikes View

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Shares of The Gap Inc. (GPS - Free Report) jumped 7% after the market trading session on Aug 26, following better-than-expected top and bottom-line numbers for second-quarter fiscal 2021. Both earnings and sales improved year over year. Results gained from continued strength at Old Navy and Athleta brands as well as renewed momentum at Banana Republic. Improved marketing efforts, better brand management and advanced technology also aided quarterly growth.

The company remains on track with its integrated loyalty program, Old Navy's inclusive shopping initiative and BODEQUALITY, all of which are part of its Power Plan 2023. Driven by these factors, management raised the fiscal 2021 view.

In the fiscal second quarter, the company’s earnings of 70 cents per share beat the Zacks Consensus Estimate of 47 cents. Earnings per share also improved substantially from a loss of 5 cents in the year-ago quarter.

Net sales improved 29% year over year and 5% from the 2019 pre-COVID levels to $4,211 million and surpassed the Zacks Consensus Estimate of $4,173 million. The top line has been benefiting from strength in its Old Navy and Athleta brands. However, the permanent closure of certain stores along with the sale of the Janie & Jack and Intermix businesses hurt sales by roughly 8% as compared with second-quarter fiscal 2019. Store closures outside the United States, stemming from the pandemic, also led to a sales decline of nearly 2% on a two-year basis.

Despite store openings, the company continued to witness strength in the online business, with digital sales increasing 65% from the second quarter of fiscal 2019, accounting for 33% of total sales in the reported quarter. Consolidated in-store sales declined 11% from second-quarter fiscal 2019 due to divestitures, permanent store closures as part of the Power Plan 2023 strategy and COVID-related closures outside the United States.

Comparable sales (comps) rose 3% year over year and 12% from second-quarter fiscal 2019. Comps included online sales as well as the comparable sales days for stores that were open on the same days in both 2020 and 2019 comparable periods.

In the past three months, shares of this Zacks Rank #2 (Buy) company have gained 32% compared with the industry’s 14.2% growth.

 

Zacks Investment Research
Image Source: Zacks Investment Research

 

Brand-wise Sales & Comps

Old Navy: Net sales at Old Navy Global improved 21%, while comps increased 18% from the pre-pandemic levels. On a year-over-year basis, comps remained flat year over year for the Old Navy brand. Sales gained from customer acquisition, stemming from the strong demand for the loyalty launch and the introduction of inclusive sizing via the BODEQUALITY launch. The brand remains well-poised for growth during the current back-to-school season.

Gap Global: In second-quarter fiscal 2021, net sales declined 10% at Gap Global. Comps for Gap Global rose 3% from second-quarter fiscal 2019 and declined 5% year over year for Gap. The Gap brand witnessed strength in key categories, including sleep, active and fleece. It is progressing well with its Partner to Amplify strategy with the recent collaboration with Walmart. The brand also completed the first Yeezy Gap Presale with a strong customer response.

Banana Republic: Net sales declined 15% and comps were down 5% on a two-year basis.  On a year-over-year basis, comps rose 41%. The transformation at the Banana Republic brand is underway, as the brand is regaining momentum on the back of improved product assortment and lower discounts. It remains focused on redefining affordable luxury by improving the online and store shopping experience.

Athleta: Net sales improved 35% for the Athleta brand, while comps increased 27% from the 2019 comparable period. Comps improved 13% on a year-over-year basis. Segment results gained from performance lifestyle products, strong customer loyalty and inclusive sizing strategy. Increased brand awareness and the launch of its digital platform AthletaWell also bode well.

Margins & Costs

Gross profit of $1,823 million reflected a 58.7% increase from $1,143 million in the prior-year quarter and improved 17% on a two-year basis. Gross margin of 43.3% expanded 440 basis points (bps) from second-quarter fiscal 2019, backed by 330-bps leverage from lower rent and occupancy costs, stemming from online growth, store closures and negotiated rent.

Gross margin benefited from a 110-bps expansion in merchandise margins, driven by strong product acceptance, which led to lower discounts. Favorable merchandise margins offset 130 bps of headwinds related to higher shipping costs incurred due to growth in online sales.

Adjusted operating expenses declined 31.4% year over year but increased 11% on a two-year basis to $1,414 million. The increase in operating expenses can be attributed to higher marketing investments and a rise in compensation costs. Adjusted operating expense rate of 33.1% increased 260 bps from second-quarter fiscal 2019.

Adjusted operating income of $409 million increased substantially from $73 million in second-quarter fiscal 2020 and $282 million in second-quarter fiscal 2019. Adjusted operating margin of 10.2% expanded 190 bps as compared to second-quarter fiscal 2019.

Other Financials

Gap ended the fiscal second quarter with cash, cash equivalents, and short-term investments of $2,712 million, representing 22.5% growth from $2,213 million in the year-ago period. As of Jul 31, 2021, it had total stockholders’ equity of $3,020 million and long-term debt of $2,220 million.

In second-quarter fiscal 2021, the company generated free cash flow of $523 million compared with a negative free cash flow of $295 million in the year-ago period due to COVID-related impacts.

In the reported quarter, the company paid out a cash dividend of 12 cents and repurchased $55 million under its existing share-repurchase plan of up to $200 million in fiscal 2021.

For fiscal 2021, the company anticipates capital expenditure of $800 million.

Store Update

As of Jul 31, 2021, Gap had 3,494 stores in more than 40 countries, out of which 2,937 were company-operated and 557 were franchise outlets.

In fiscal 2021, the company plans to close 75 Gap and Banana Republic stores in North America. It also expects to open 30-40 Old Navy and 20-30 Athleta stores.

The Gap, Inc. Price, Consensus and EPS Surprise

 

Fiscal 2021 Guidance

Backed by strong quarterly results, Gap raised its view for fiscal 2021. It now envisions adjusted earnings of $2.10-$2.25 per share compared with $1.60-$1.75 mentioned earlier. GAAP earnings per share are now expected to be $1.90-$2.05, up from the earlier mentioned $1.55-$1.70.

The company expects year-over-year sales growth of 30% from that reported in fiscal 2020 as compared with the low-to-mid 20-percent range stated earlier. The company’s sales guidance includes revenues lost due to the divestitures of Janie and Jack, and Intermix as well as changes in its European operating model.

The company expects reported and adjusted operating margin of 7%, up from 7.5% mentioned earlier. The updated view is driven by the strong fiscal second-quarter performance and the company’s progress on achieving its targeted 10% operating margin rate by 2023, in sync with its Power Plan 2023. It anticipates adjusted effective tax rate of 25% for fiscal 2021.

Business Development

Gap acquired an e-commerce startup and online application, Drapr, for customers to help get the better clothing size and fit via advanced 3D technology and a virtual try-on service. The move will also reduce unnecessary returns and is in sync with the company’s ongoing digital transformation.

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