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Gap (GPS) Feels the Pinch of Soft Q1: Is It Time to Offload?

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The Gap Inc. (GPS - Free Report) has been putting a dismal show lately owing to bleak earnings performance in the last reported quarter. It missed earnings estimates in first-quarter fiscal 2018, after four straight quarters of beat. Further, the company is witnessing softness across its namesake brand, which has been a key impediment for quite some time.

Though shares of Gap gained 8.7% in the past three months, it lagged the industry’s 15.5% increase. Moreover, the stock has improved just 2.4% since reporting first-quarter fiscal 2018 results on May 24. Also, the stock’s Zacks Rank #4 (Sell) and VGM Score of C indicates that it has fallen out of investors’ favor.



Hurdles

The lower-than-expected earnings for the fiscal first quarter can be attributed to operating issues at the Gap brand as well as an unseasonably cold and snowy weather. These two factors together resulted in higher inventory levels and strained margins in the quarter.

Notably, Gap has been witnessing softness across its namesake brand for quite a while now. Apparently, comps fell 4% at Gap brand in first-quarter fiscal 2018, mainly owing to operational headwinds across timing of inventory, breadth of the product assortment and shortage of gaps in certain categories. The Gap brand has been undergoing operating model improvements for about a year now. While these actions should aid long-term growth for the brand, the near-term performance will continue to be impacted by the aforementioned headwinds.

The headwinds at the brand as well as the unpleasant weather also impacted gross and operating margins, which contracted 120 basis points (bps) and 110 bps, respectively, excluding the effect of the adoption of the revenue recognition standard. Particularly, miss steps regarding the timing of inventory flows affected the time on offer and the ability to optimize margin. Though the company is working on fixing these issues, it anticipates the headwinds to persist in the fiscal second quarter.

Is there Hope for Revival?

While these near-term concerns remain, the company is well poised to steer through every market situation with its core Old Navy, Gap and Banana Republic brands. Its consistent focus on enhancing product quality and responsiveness to changing consumer trends bodes well. It has also been making constant efforts to bolster digital and mobile offerings alongside improving product acceptance.

Additionally, the company has chosen to diversify into the growing athleisure market by launching a premium lifestyle and active-wear brand called Athleta. Further, it continues to witness solid growth for the Old Navy brand as evident from the robust comparable sales (comps) performance in the last few quarters. Backed by the prospects of these brands, the company announced a new growth strategy, focusing on its two growth brands: Old Navy and Athleta.

The company expects net sales of more than $10 billion and $1 billion, respectively, for each of the brands over the next few years, resulting from U.S. store expansion along with mobile and e-commerce growth. Additionally, the company plans to open 270 Old Navy and Athleta stores while simultaneously closing 200 underperforming Gap and Banana Republic stores over the next three years. In sync with this strategy, the company’s plan to open 25 stores in fiscal 2018 is likely to comprise more of Athleta and Old Navy stores while it plans to close down Gap and Banana Republic stores.

The company expects these new strategies to create about $500 million in expense savings over the next three years, portion of which will be reinvested in its growth goals.

Looking for Top-Ranked Retail Stocks, Check These

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Urban Outfitters, Inc. (URBN - Free Report) , a Zacks Rank #1 stock, has a long-term earnings growth rate of 12%. It has delivered an average positive earnings surprise of 19.8% in the last four quarters.

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