The Gap, Inc. (GPS Quick QuoteGPS - Free Report) has been reeling under shifting consumer preference from casual wear to dressier clothes, as well as higher inventory, a tough macroeconomic environment and elevated costs. Also, the apparel company has suddenly taken a hit, as rising costs are making people spend cautiously.

This led to a year-over-year decline in the top and bottom-line performances in second-quarter fiscal 2022. Adjusted earnings of 8 cents per share compared unfavorably with earnings of 70 cents reported in second-quarter fiscal 2021. Net sales declined 8% year over year to $3,857 million. Comparable sales (comps) slumped 10% on a year-over-year basis.

Also, the adjusted gross margin of 36% contracted 730 basis points (bps) year over year due to a 700-bps decline in adjusted merchandise margins stemming from $50 million of higher air freight. Huge discounts at Old Navy and rising commodity price increases were somewhat offset by fewer discounts at Banana Republic. The adjusted operating margin contracted 850 bps year over year to 1.7%.

The company has been witnessing elevated freight expenses, which led to higher inventory in second-quarter fiscal 2022. Gap’s total inventory rose 37.4% year over year due to longer transit times, more delays, pack-and-hold strategies, and elevated AUC and input costs.

Due to the above-mentioned factors, shares of GPS have plunged 13.3% in the past three months, underperforming the industry’s decline of 9.6%.

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Efforts to Counter Hurdles

Strength in Athleta remained an upside for Gap. The Athleta brand’s value-driven active and lifestyle categories, increased digital marketing investments, and focus on product strategy have been aiding sales.

In second-quarter fiscal 2022, set sales jumped 1% for the Athleta brand, driven by increased awareness, along with strength in the women’s active and wellness category. The metric also rose more than 37% from the pre-pandemic levels. Increased focus on performance active, as well as active lifestyle products, to capitalize on the evolving shopping trends bodes well. Driven by these factors, Athleta remains on track to reach $2 billion in net sales by fiscal 2023.

Going ahead, the company expects to invest cautiously in marketing, pause hiring plans and slow down its spending on technology. Management remains optimistic about sales in the second half of fiscal 2022. Air freight costs are likely to lower in the second half of fiscal 2022.

Although the company entered the fiscal third quarter with higher inventory, it expects inventory to reduce significantly by the end of fiscal 2022. Gap is undertaking actions to lower operating expenses, which are likely to create headwinds in fiscal 2023. The bottom line in the fiscal third quarter is expected to gain from the sale of its UK distribution center.

This Zacks Rank #3 (Hold) company remains on track with its Power Plan 2023, which focuses on opening highly profitable Old Navy and Athleta stores, while closing the underperforming Gap and Banana Republic stores. As part of the plan, the company expects the Old Navy and Athleta brands to contribute 70% to sales by 2023.

In sync with its fleet-optimization efforts under the Power Plan 2023, the company aims to close 50-60 Gap and Banana Republic stores in North America in fiscal 2022. With the closing of underperforming Gap and Banana Republic stores, it expects to realize $100 million in EBITDA savings annually by 2023-end. Also, the company expects the e-commerce business to contribute 50% to sales by the end of 2023.

Bottom Line

Gap is leaving no stone unturned to reduce inventory and rebalance its assortments to attract customers. Also, strength in its Athleta brand and the Power Plan 2023 strategy are likely to help aid Gap’s performance in the near future. Topping it, a VGM Score of B and a long-term earnings growth rate of 12% raise optimism in the stock.

Stocks to Consider

Here are three better-ranked stocks to consider — Dollar General (DG Quick QuoteDG - Free Report) , Dillard’s (DDS Quick QuoteDDS - Free Report) and Ulta Beauty (ULTA Quick QuoteULTA - Free Report) .

Dollar General, a discount retailer, currently carries a Zacks Rank #2 (Buy). DG has an expected EPS growth rate of 12.8% for three to five years. You can see the complete list of today’s Zacks #1 Rank stocks here.

The Zacks Consensus Estimate for Dollar General’s current financial-year revenues and EPS suggests growth of 10% and 13.4%, respectively, from the year-ago reported figure. Dollar General has a trailing four-quarter earnings surprise of 2.8%, on average.

Dillard's, which operates retail department stores, currently sports a Zacks Rank #1. The company has a trailing four-quarter earnings surprise of nearly 215%, on average.

The Zacks Consensus Estimate for Dillard's current financial-year sales suggests growth of 6% from the year-ago reported figure. DDS has an expected EPS growth rate of 14.6% for three to five years.

Ulta Beauty, which operates as a retailer of beauty products, sports a Zacks Rank #1 at present. The company has a trailing four-quarter earnings surprise of 32.8%, on average. ULTA has an expected EPS growth rate of 11.9% for three to five years.

The Zacks Consensus Estimate for Ulta Beauty’s current financial-year sales suggests growth of 13.7% from the year-ago reported number.