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Gap (GPS) Down 12% in 6 Months: Can Efforts Aid Turnaround?

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The Gap, Inc. (GPS - Free Report) stock has been suffering owing to dismal comparable sales (comps) trend in the past few quarters. Investor sentiment for the stock was further hurt by third-quarter fiscal 2019 results, which were impacted by persistent soft performance across all brands as well as weak traffic trends. Also, strained margins and higher expenses remain  added concerns. Further, management cut sales and comps guidance.

A glimpse at this stock’s price performance reveals that it has underperformed the industry in the past six months. Shares of this San Francisco, CA-based company have lost approximately 12%, wider than the industry’s 6.2% decline.

Moreover, unimpressive estimate revision trend for the fourth quarter and fiscal 2019 is a concern. Over the past 30 days, the Zacks Consensus Estimate has moved down by 48.5% and 16% for the fourth quarter and fiscal 2019, respectively, to 34 cents and $1.73.



Reasons for Gap’s Distress

In third-quarter fiscal 2019, total comps declined 4% compared with flat numbers in the year-ago period. Comps were impacted by declines across all three brands mainly due to soft traffic trends. Comps declined 4% at Old Navy, 3% at Banana Republic and 7% at the Gap brand. Old Navy’s comps were affected by continued challenges in product acceptance as well as weak traffic. The Banana Republic brand was impacted by softness in some products due to warmer-than-expected weather along with sub-optimal mix regarding sizes, owing to its efforts to fully implement a new inventory management tool. Gap brand reported comps decline due to store closures.

Also, adverse foreign currency translations weighed on its sales, which dipped 2.2% in the fiscal third quarter. In addition, adjusted gross margin contracted 70 basis points (bps), due to softness in the Old Navy brand. Merchandise margin contracted 50 bps mainly owing to softness in Old Navy and Banana Republic, somewhat mitigated by Gap and Athleta brands. Adjusted SG&A expenses expanded 70 bps on lower sales as well as higher technology-related investments. Consequently, adjusted operating margin declined 140 bps.

The company expects gross margin to deleverage in fiscal 2019. The company now anticipates comps decline in mid-single digits compared with low-single-digit decline mentioned earlier. Moreover, it now expects net sales decline in low-single digits versus flat year-over-year sales stated previously.

Can Efforts Aid Revival?

Gap is on track to spin off into two stand-alone public companies, new Gap Inc. and Old Navy. The transaction is expected to close in 2020. The rationale behind the separation mainly includes improved focus, better cost and efficiency, and enhanced profitability. The focus from separation will help the two companies better serve their distinct customer sets, each with an operating model tailored to their respective business needs. It will also serve as a catalyst in improving costs and efficiency as the companies rebuild the organization structures and operating models. Moreover, it will empower both the companies to deliver sustained profitability.

Apart from this, management remains on track to revitalize the Gap brand by streamlining its specialty fleet and enhancing the marketing model to drive customer engagement. The company is also focused on driving profitability through improved product assortment and inventory composition as well as reduced promotional activity. Though it has a long way to go before restoring the brand to profitability, results in the third quarter of fiscal 2019 were relatively better. The company witnessed positive margins and traffic trends for the Gap brand in the third quarter, owing to its efforts to drive profitability through improved product assortment and inventory composition as well as reduced promotions.

We believe that these efforts will take time to yield favorable results and win back investors’ confidence in this Zacks Rank #5 (Strong Sell) stock. However, the current dismal performance remains a concern for the company in the near term.

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