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Gap's (GPS) Q4 Earnings Meet, Currency Leads to Soft View

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The Gap Inc. (GPS - Free Report) came out with fourth-quarter fiscal 2016 results, wherein the company continued with its usual trend of posting in-line earnings, alongside delivering its third consecutive sales beat. These results clearly reflect the effects of the company’s ongoing turnaround plan. Positive comparable store sales (comps) growth, which in turn was driven by continued growth at Old Navy, was another highlight of the holiday quarter.

However, results continued to be impacted by foreign currency headwinds, costs associated with store closures which were announced by Gap earlier, and persistent weakness across the company’s Banana Republic brand.

While the stock didn’t react much to the earnings announcement in the after-market trading session, shares of Gap have outperformed the Zacks categorized Retail – Apparel/Shoe industry in the last three months. The company’s shares fell 5.3% in the last three months, while the industry witnessed a decline of 12.6%.
 



Q4 Highlights     

Gap’s adjusted earnings of 51 cents a share came in line with the Zacks Consensus Estimate, but dropped significantly from $2.02 recorded in the year-ago period. On a GAAP basis, earnings came in at 55 cents per share, down considerably from $1.69 reported in the year-ago period.

Gap, Inc. (The) Price, Consensus and EPS Surprise

 

Gap, Inc. (The) Price, Consensus and EPS Surprise | Gap, Inc. (The) Quote

Fuelled by favorable comps, net sales improved 1% to $4,429 million, thus breaking its seven-quarter long trend of year-over-year decline. Also, the top line surpassed the Zacks Consensus Estimate of $4,395.5 million. While sales continued to be hurt by soft Banana Republic’s performance, Old Navy’s continued strength more than offset the weakness.

Comps for the fiscal-fourth quarter jumped 2%, against a 7% decline recorded in the year-ago period. This was largely attributable to a successful holiday season that benefited from favorable customer response for the Gap and Old Navy brands. While the early November results were dampened by soft traffic at stores and malls, the pace picked up in December.

Margins

Gross profit jumped 4.2% to $1,501 million, with the gross margin expanding 110 basis points (bps) to 33.9%. We believe that this is largely attributable to strong merchandise margins, which increased 50 bps in the quarter.

Operating income, however, declined 15.2% to $301 million, with the operating margin contracting about 130 bps to 6.8%, mainly owing to elevated marketing and operating expenses, with the latter also including costs related to the restructuring initiatives announced in May 2016.

Fiscal 2016 & Other Developments

Catching a glimpse of fiscal 2016, Gap’s adjusted earnings came in at $2.02, down 17% year over year. However, the figure came in line with the Zacks Consensus Estimate. Net sales of $15,516 million dipped 1.8% year over year, while beating our estimate of $15,485 million.

Adverse currency fluctuations dented fiscal 2016 adjusted earnings by nearly 15 cents in the quarter. Further, sales in the fiscal were negatively impacted by currency translations to the tune of nearly $20 million.

During the fourth quarter, Gap’s namesake brand’s operating model remained on track, which helped boost product acceptance across key categories. Also, in a drive to enhance its digital strategies, Gap introduced a new app – “DressingRoom by Gap.” This app will enable customers to try clothes through reality experiences generated via smart phones.

Further, Gap’s Athleta brand is progressing well with its innovations and efforts toward becoming a performance and lifestyle brand, as evident from its solid footprint by the end of fiscal 2016. Finally, in fiscal 2016, Gap’s mobile point of sale improved to nearly 20% of its domestic fleet. This in turn, has been helping store associates to enrich customer experiences, thus highlighting the company’s focus on augmenting omnichannel and digital operations.

Financials

Gap ended fiscal 2016 with cash and cash equivalents of $1,783 million, long-term debt of $1,248 million, and total shareholders’ equity of $2,904 million.

During fiscal 2016, the company generated cash flow from operations of $1,719 million and incurred capital expenditure of $524 million. Additionally, the company’s total free cash inflow for the fiscal totaled $1.2 billion, including proceeds of about $73 million from the Fishkill fire calamity.

For fiscal 2017, management projects capital expenditure of approximately $625 million, excluding the spending associated with reconstructing the Fishkill distribution center.

Coming to Gap’s shareholder-friendly moves, it announced a first quarter dividend of 23 cents per share, which will be payable on Apr 26 to shareholders of record as on Apr 5. Also, the company plans to make buybacks of roughly $100 million in the first half of fiscal 2017. Gap currently has buybacks worth $1 billion remaining under its standing authorization.

Store Update

In the fourth quarter, Gap introduced 30 stores, while shuttering 113 company-operated stores. It ended the fiscal with 3,659 outlets in 50 countries, of which 3,200 were company-operated and 459 were franchise. Square footage of company-operated stores declined about 3% year over year.

Notably, Gap closed its Old Navy Japan business in fiscal 2016, alongside shuttering down several dilutive Banana Republic stores (mainly global).

In fiscal 2017, Gap anticipates to open roughly 40 company-operated stores, net of store closures and repositions. As per plan, the new stores will be primarily focused on Athleta and Old Navy, while store closures will be mainly concentrated on the namesake brand.

Outlook

Management remains impressed with the solid end to fiscal 2016, given the sales momentum witnessed in the crucial holiday quarter. However, in fiscal 2017, the company expects to continue being hurt by the perils of foreign currency movements. That said, management issued a fresh outlook for fiscal 2017.

During the fiscal, management anticipates comps growth to range from flat to improve marginally. Net sales, are expected to be little lower than this range, owing to the currency challenges.

Consequently, the company envisions earnings for the fiscal year to range from $1.95−$2.05 per share, including a negative currency impact of about 9 cents (or 5% EPS growth). The guidance compares unfavorably with the current Zacks Consensus Estimate of $2.07.

Moreover, management expects reported earnings per share to be down in high single digits in the first half of fiscal 2017.

Zacks Rank & Key Picks

Gap currently carries a Zacks Rank #3 (Hold).

Better-ranked stocks worth considering in the same industry include The Children's Place, Inc. (PLCE - Free Report) , Kate Spade & Company and Zumiez Inc. (ZUMZ - Free Report) , each with a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

Children's Place has an average positive earnings surprise of 36.3% in the trailing four quarters. The stock, with a long-term growth rate of 10.3%, has seen positive estimate revisions in the last 60 days.

Kate Spade, with long-term earnings per share (EPS) growth rate of 28.3%, has seen positive estimate revisions over the past 30 days.

Zumiez’s long-term EPS growth rate of 15% and solid positive estimate revisions over the past 30 days help it stand strong in the industry. Moreover, the company flaunts a superb earnings surprise history.

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