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Gap (GPS) Tops Q4 Earnings Estimates, Provides Cautious View

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The Gap Inc. (GPS - Free Report) reported top and bottom-line beat in fourth-quarter fiscal 2019. While its sales improved on a year-over-year basis, earnings declined. Results continued to reflect the impacts of soft consolidated comparable sales (comps) for its Gap brand, while Old Navy and Banana Republic brands remained flat.

Shares of Gap rose 1.3% in the after-hours trading session on Nov 21, owing to the earnings and sales beat. In the past three months, shares of the Zacks Rank #2 (Buy) company have lost 40.9% compared with the industry’s 31.6% decline.

However, Gap provided a cautious view for fiscal 2020, given the outbreak of coronavirus in China, Japan and Europe, and the emerging situation in the United States.

 

 

Q4 Highlights

In the fiscal fourth quarter, the company’s adjusted earnings of 58 cents per share surpassed the Zacks Consensus Estimate of 41 cents. However, the bottom line declined 19.4% from 72 cents registered a year ago.

On a reported basis, the company delivered a loss per share of 49 cents. This included costs related to the previously planned separation, specialty fleet restructuring, and non-cash impairment charges related to store assets and operating lease assets of Gap’s flagship stores.

The Gap, Inc. Price, Consensus and EPS Surprise

 

The Gap, Inc. Price, Consensus and EPS Surprise

The Gap, Inc. price-consensus-eps-surprise-chart | The Gap, Inc. Quote

Net sales rose 1.1% year over year to $4,674 million and beat the Zacks Consensus Estimate of $4,517 million. Sales included the effects of positive foreign currency translations of $7 million in the reported quarter. Total comps declined 1% compared with a 1% fall in the year-ago period.

Comps gained from growth in Athleta, and flat results in the Old Navy and Banana Republic brands, offset by a decline at the namesake brand. Notably, comps remained flat at both Old Navy and Banana Republic brands against flat comps and a 1% decline reported in the prior-year quarter, respectively. At the Gap brand, comps declined 5% compared with a 5% fall in the year-ago quarter. However, comps improved 2% for Athleta versus 7% growth in the prior-year period.

Margins

Adjusted gross profit in the quarter under review increased 3% to $1,696 million and gross margin expanded 70 basis points (bps) to 36.3%.

Merchandise margin expanded 30 bps, excluding the impact of restructuring mainly due to growth at Old Navy and Athleta, somewhat mitigated by deleveraging at the Gap and Banana Republic brands. Meanwhile, rent and occupancy were nearly flat as a percentage of sales and leveraged 40 bps, excluding restructuring.

Adjusted operating expenses increased 280 bps to 30.3%, excluding the flagship impairment charges, separation-related costs and specialty fleet restructuring costs. The deleverage is attributed to a rise in expenses related to information technology, an increase in bonus expenses compared with lower bonus expenses incurred in fiscal 2018, and an increase in advertising expenses due to increased spending at Old Navy.

Consequently, adjusted operating income declined 25.3% to $278 million, with adjusted operating margin contracting 210 bps to 5.9%.

Financials

Gap ended fiscal 2019 with cash and cash equivalents of $1,364 million, long-term debt of $1,249 million, and total stockholders’ equity of $3,316 million.

In fiscal 2019, the company generated net cash flow from operations of $1,411 million and incurred capital expenditure of $702 million. As of Feb 1, 2020, Gap had free cash flow of $709 million.

Coming to the shareholder-friendly moves, the company paid out $364 million in dividends and returned $200 million through share repurchases. It bought back 2.9 million shares for approximately $50 million and paid out a dividend of 24.25 cents per share in the fiscal fourth quarter. In fiscal 2019, the company repurchased 10.4 million shares for $200 million. Furthermore, on Mar 4, it announced a dividend of 24.25 cents per share for the fiscal first quarter.

For fiscal 2020, management projects capital expenditure of $600 million, including $50 million of costs related to the continued expansion of its Ohio distribution center.

Store Update

On a net basis, the company opened 99 Old Navy and Athleta stores, and acquired 139 Janie and Jack stores in fiscal 2019. Meanwhile, it closed 87 Gap, Banana Republic and Intermix stores. In fiscal 2019, the company closed 141 Gap brand stores globally, of which 79 were related to the ongoing restructuring program, primarily in North America.

Gap ended fiscal 2019 with 3,919 outlets in 42 countries, out of which 3,345 were company-operated and 574 were franchise outlets.

For fiscal 2020, the company expects the closure of 90 company-operated stores, net of openings and repositions. The projection includes the closure of 170 Gap brand stores globally related to the restructuring of the Gap brand fleet. Most of these store closures are expected to occur in fourth-quarter fiscal 2020. Simultaneously, it remains committed toward store openings for Athleta and Old Navy locations.

As part of its ongoing restructuring program, the company continues to target closing 230 specialty stores by the end of 2020. The closures are likely to entail total costs of $250-$300 million, including the estimated buyout costs of four flagship locations. For the two-year program, the company expects the closures to result in an annualized sales loss of $625 million and annualized pre-tax savings of $90 million.

As already mentioned, the company expects to close 170 Gap stores globally in 2020. The closures will likely result in restructuring costs of $190-$240 million, with the majority expected to be cash expenditure.

Outlook

Given the coronavirus outbreak, the company expects uncertainty mainly related to supply-chain disruptions and soft customer demand. Regarding the supply chain, it has migrated its vendors from China in the past year and currently sources only 16% of goods from China (down from 21%). However, it expects to witness the impacts of factory closures in China, as a large portion of fabrics is produced in mills in China, which is supplied by vendors outside China.

Coming to demand suppression, the company expects significant impacts from store closures and soft traffic trends in China, which is the most affected region and accounts for 3% of Gap’s global sales. Further, it anticipates negative impacts from Japan and Europe due to store closures and reduced traffic.

Further, the company stated that it is unable to provide a reasonable estimate of the impact of coronavirus in the United States, where cases have just started to emerge. However, based on the coronavirus outbreak in China, Japan and Europe, it currently expects negative impacts of $100 million on sales or 10 cents on earnings per share for first-quarter fiscal 2020.

Further, given the current economic uncertainty due to the coronavirus outbreak and other factors, the company suspended its share repurchase program for fiscal 2020.

For fiscal 2020, it expects earnings per share of $1.23-$1.35, on a reported basis. Excluding restructuring costs, adjusted earnings per share are anticipated to be $1.80-$1.92. Adjusted earnings will likely include the aforementioned impact of 10 cents per share from the coronavirus outbreak in China, Japan and Europe.

Further, as the company continues to execute its specialty fleet restructuring program, it expects both comps and net sales for fiscal 2020 to decline in low-single digits. Comps results will mainly be impacted by negative comps expected for the Gap brand, offset by positive comps at Old Navy, Athleta and Banana Republic.

Gap expects effective tax rate of 30%. Excluding certain non-cash tax impacts related to expected restructuring charges, the company predicts adjusted effective tax rate of 26%.

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