The Gap Inc. (GPS - Free Report) reported mixed fourth-quarter fiscal 2018 results, wherein earnings surpassed estimates while sales lagged. Notably, the company delivered positive earnings surprise in seven of the last eight quarters, while it missed sales estimates after eight consecutive beats. Further, management issued an outlook for fiscal 2019.
Nevertheless, shares of the company that belongs to Retail - Apparel and Shoes industry were up about 25.6% in after-hours trading on Feb 28. This rally is mainly owing to the announcement of its intention to spin off into two companies - Old Navy and a yet-to-be-named (‘NewCo’). However, shares of Gap have lost 9.9% in the past three months, wider than the S&P 500’s 0.2% decline.
The Spin Off
Gap unveiled plans to spin off into two independent public companies. The NewCo, with roughly $9 billion revenues annually, will house the Gap, Athleta, Banana Republic, Intermix and Hill City brands. The company expects Old Navy, which is among the fast-growing apparel brands with about $8 billion revenues in a year, to enhance its omni-channel capabilities and product offerings to boost customer experience and gain market share.
The transaction, which is expected to close in 2020, is subjected to some conditions that also include final approval by Gap’s board of directors. After the spin-off, Gap’s shareholders will receive a pro-rata stock distribution and as a result of that, is expected to own shares in both NewCo and Old Navy equally.
Management expects the spin-off to enable the two stand-alone companies to strategically focus on their initiatives and operating structure in order to capitalize on growth opportunities and well positioned in the challenging retail space.
In the fiscal fourth quarter, Gap’s earnings of 72 cents per share outpaced the Zacks Consensus Estimate of 68 cents. The bottom line also improved nearly 18% from 61 cents registered a year ago. Quarterly earnings included currency tailwinds of 1 cent per share.
Net sales declined 3.2% to $4,623 million and missed the Zacks Consensus Estimate of $4,711 million. The top line also fell 7% year over year due to the adoption of the new revenue recognition standard, excluding the presentation changes. These changes contributed $170 million to the top line decline. Moreover, foreign currency translations negatively impacted revenues by $28 million.
Further, the company is likely to adopt ASU No. 2016-02, Leases in the first quarter of fiscal 2019.
Coming back to numbers, total comparable sales (comps) inched down 1% compared to 5% growth in the year-ago period. Further, comps remained flat at Old Navy versus 9% improvement in the prior-year quarter. However, comps declined 1% and 5% at Banana Republic and Gap. In the year-ago quarter, comps rose 1% at Banana Republic and were flat at the company’s namesake brand.
Nevertheless, this Zacks Rank #3 (Hold) company has announced plans to revitalize its Gap brand by streamlining the specialty fleet and renewing the marketing model to enhance customer engagement and loyalty. In relation to streamlining specialty fleet, it expects to shut down roughly 230 stores in the next two years. This will result in sales decline of nearly $625 million annually. Moreover, management estimates pre-tax costs of $250-$300 million. Also, these restructuring measures are likely to generate annualized pre-tax savings of nearly $90 million.
Further, these actions will lead to about 40% of sales from online, while 60% will come from the specialty and value channels.
While gross profit fell 6% to $1,645 million, gross margin expanded 140 basis points (bps) to 35.6%. Excluding the impact of presentation changes from the revenue recognition standard, gross profit declined 13% while gross margin contracted 260 bps to 34.2% mainly due to lower merchandise margin coupled with rent and occupancy deleverage.
Operating income declined 6.1% to $372 million while operating margin contracted 30 bps to 8%. Excluding the impact of the revenue recognition standard, operating margin rose 10 bps to 8.4%.
Gap ended the quarter with cash and cash equivalents of $1,081 million, long-term debt of $1,249 million, and total stockholders’ equity of $3,553 million.
In fiscal 2018, the company generated net cash flow from operations of $1,381 million and incurred capital expenditures of $705 million. Gap had free cash flow of $676 million as of Feb 2, 2019.
Coming to Gap’s shareholder-friendly moves, the company bought back 3.8 million shares for approximately $98 million and paid a dividend of 24.25 cents per share in the fiscal fourth quarter. This dividend reflects more than 5% growth year over year. In fiscal 2018, the company bought back 13.8 million shares for $398 million.
Additionally, management authorized a new share repurchase program worth $1 billion, replacing its existing program. Also, it announced a dividend of 24.25 cents per share for first-quarter fiscal 2019, payable on or after May 1, 2019, to its shareholders of record as of Apr 10.
For fiscal 2019, management now projects capital expenditures of roughly $750 million that comprises $100 million of expansion charges associated with one of its headquarters buildings as well as the development of the Ohio distribution facility. Also, Gap inked a deal to buy the Old Navy headquarters building as well as intends to sell another property in fiscal 2019. Furthermore, net cash outflows are projected to be approximately $100-$150 million.
In fiscal 2019, management anticipates spending $200 million for share buybacks.
In the fiscal fourth quarter, Gap opened 54 company-operated and six franchise stores, while closed 78 company-operated and four franchise stores. Consequently, Gap ended fiscal 2018 with 3,666 outlets in 43 countries, of which 3,194 were company-operated and 472 were franchise stores.
In fiscal 2019, Gap anticipates to shut down nearly 50 company-operated stores, net of openings and repositions. This projection consists of closing 130 stores related to the restructuring of the Gap brand fleet. However, most of these stores are expected to be closed in fourth-quarter fiscal 2019. Simultaneously, it expects to open more of Athleta and Old Navy stores.
Management issued guidance for fiscal 2019, wherein it anticipates comps to be flat to up slightly. Moreover, it estimates effective tax rate of roughly 26%.
Consequently, the company envisions earnings per share of $2.11-$2.26 for the fiscal year. Excluding the anticipated costs associated with the restructuring of its flagship brand, earnings are estimated to come in at $2.40-$2.55, which is significantly below the current Zacks Consensus Estimate of $2.63 for fiscal 2019.
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