Gap’s Profit Plunges on Sluggish Sales, Higher Expenses

Retailer’s net sales fell 1.2% to $3.85 billion, comp sales fell 2% during Q2 FY16

g1The Gap Inc. (NYSE: GPS), a US-based global specialty retailer that markets its products under the Gap, Old Navy, Banana Republic, Piperlime, and Athleta brand names, announced its Q2 FY16 financial results on August 18th, 2016.

The San Francisco, California-based Company sells its products in more than 90 countries worldwide through about 3,300 company-operated stores, about 450 franchise stores, and e-commerce sites. Its FY15 net sales were $15.8 billion. The Company’s omni-channel services, including order-in-store, reserve-in-store, find-in-store and ship-from-store, are offered across all its brands. Gap has company-operated stores in the U.S., Canada, the U.K., France, Ireland, Japan, Italy, China, Taiwan, and Hong Kong. It operates Gap, Banana Republic, and Old Navy stores in Asia, Australia, Europe, Latin America, the Middle East and Africa. Read more about Gap’s financial results below.

Q2 FY16 financial highlights

During Q2 FY16, net sales fell 1.2% to $3.85 billion compared to $3.90 billion in the year-ago period. Comp sales fell 2% during the reporting quarter. By division, Gap Global suffered a 3% decline in comp sales versus a 6% decline in the year-ago quarter, Banana Republic saw a 9% fall in comp sales versus a 4% last year, while lower-priced Old Navy reported flat comp sales versus 3% growth in the year-ago period.

g2Gap is faced with sluggish sales at its stores as shoppers buy less clothing in general and shop more at off-price chains, forcing the Company to offer massive discounts to attract customers. CEO Art Peck, who took over in 2015, said that the Company has taken major steps in its restructuring plans to build a brand with more growth potential. As part of its growth strategy, Gap is offering high-tech fabrics like stain-resistant clothes and adding more stretch in men’s clothing. The company is also testing smaller-sized Old Navy stores, while adding more varieties of athletic-inspired clothing at Gap and Old Navy stores. Gap has done well with its Athleta stores, which focus on active wear. Gap is also focusing on better fitments, since bad fits have posed problems for the company, particularly with online sales. On the brighter side, an uptick in apparel spending, especially in Gap’s core denim category, could help the Company fight sluggish mall traffic and heavy discounting.

g3During Q2 FY16, Gap’s operating expenses were $1.16 billion compared to $1.09 billion for the prior-year period. Excluding restructuring costs for Q2 FY16 and Q2 FY15, operating expenses were about flat versus the year-ago quarter. Marketing expenses for Q2 FY16 were $131 million, about flat versus the year-ago period.

In all, sluggish sales and higher expenses weighed on Gap’s Q2 FY16 net income, which nosedived 43% to $125 million, or $0.31 per share, compared to $219 million, or $0.52 per share, a year earlier. Adjusted earnings were higher at $0.60 per share during Q2 FY16.

Gap ended Q2 FY16 with $1.7 billion in cash and cash equivalents. Year-to-date free cash flow was at $464 million.

Other highlights

Inventory: At the end of Q2 FY16, total inventory dollars were down 3%, in-line with the Company’s previous guidance. At the end of Q3 FY16, Gap expects total inventory dollars to be down in the low single digits year-over-year.

g4Stores update: Gap announced in May 2016 that it was closing 75 Old Navy and Banana Republic stores outside North America. The move affects just a fraction of the more than 3,700 stores that Gap operates globally and should result in annual savings of $275 million before taxes.

At the end of Q2 FY16, Gap operated 3,730 store locations in 52 countries, of which 3,273 were company-operated, translating into square footage of 37.8 million. During Q2 FY16, Gap opened 19 and closed 22 company-operated stores. Square footage of company-operated stores was down about 1% to 37.8 million versus the year-ago period. Gap expects net closures of about 50 company-operated stores in FY16. Additionally, the company continues to expect square footage to be down about 2% for FY16 versus FY15.

New appointments: In April 2016, Gap named Sonia Syngal as global head for the Old Navy division. She had been an executive vice president in charge of the company’s supply chain. On August 11th, 2016, Gap announced that Brian Goldner has been elected to serve on the Board of Directors effective August 12th, 2016.

Capital Expenditures: Gap’s year-to-date capital expenditures were $270 million. For FY16, Gap expects capital spending to be approximately $525 million.

Guidance for Q3 FY16 and full year FY16

Gap expects diluted EPS for FY16 to be in the range of $1.37 to $1.47. Excluding the negative impact of restructuring costs, which is expected to be approximately $0.45 to $0.50, Gap expects its adjusted diluted EPS to be in the range of $1.87 to $1.92. Excluding restructuring costs, the Company expects its adjusted operating margin to be about 8.5% in FY16.

Stock Performance

g5Gap’s stock ended the day at $26.63, slipping 1.33%, at the close on Wednesday, August 24th, 2016, having vacillated between an intraday high of $27.03 and a low of $26.61 during the session. The stock’s trading volume was at 4,491,619 for the day. The Company’s market cap was at $10.20 billion as of Wednesday’s close.

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