The Exchange

Gap Earnings Preview: Investors Should Manage Expectations

The Exchange

By Marek Fuchs

Gap (GPS), the nation’s biggest mall retailer, today stands somewhere better than bruised if still short of being permanently healed from past wounds. The evident improvement of its stores – to stay nothing of the stock’s bumptious performance over the past year, up roughly two-thirds since the start of 2012 – has, however, led to a slightly unwarranted sense of certainty over Gap’s earnings, which will be released after the close of Thursday’s trading.

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[See related item: Gap: Company of the Year]

“Gap's 4Q results to show continued turnaround,” says The Associated Press in a representative headline. Motley Fool, for its part, went one step further; they are already letting Gap take a victory lap, pointing to “How Gap's Focus on Brand Made the Difference” in a headline that ran a full two days before earnings.

Have the media suddenly turned telepathic ? Hardly. A key – and neither of these articles mentioned a word of it – is that Gap pre-announced its fourth-quarter sales two weeks ago.

Those sales, due to come in at $4.73 billion compared with $4.28 billion for the fourth quarter of last year, outpaced expectations but simultaneously reset expectations. In other words, it will be hard for Gap to beat a top line that has already been announced. That’s why, even as the media are reporting on the San Francisco-based retailer’s earnings with ironclad certainty, you should remember that a good deal of that certainty stems from the pre-announcement.

Top line pre-announcements aren’t the only item left off the media’s Gap agenda. Too often, credit for Gap’s recent success is ascribed to its rediscovering the religion of simplicity. Says Motley Fool, “It focused on its core strengths. No diworsification, no brand-new business lines, no learning to love again. Just a simple single-mindedness that we could all learn from.”

That’s true – to a point. But you have to factor in what The Associated Press did: While Gap’s business plan entailed a back-to-basics approach, the style on its store shelves has actually turned a bit fashion-forward.

A fashion-forward risk

The Associated Press appropriately noted Gap’s “push into brightly colored clothing [and] new designer collaborations.” Few others did. Granted: Gap is not now – nor will it ever be – the latest word in fashion. But they have evolved from their khaki past, which holds rewards (see: the past year) and possible, even probable, risks.

Given its size and scope, Gap is often seen as an economic barometer in the retailer world. That is heightened this quarter, with concerns about the impact of the rise in payroll taxes and gasoline prices – twin clubs taken to the back of the consumer’s head.

That’s why you must remember the presence of the extra week in the 4th quarter, 14 instead of 13 the year before. This is a factor the media are often forgetting in their preview coverage. The bonus week is, of course, baked into expectations of about 71 cents versus 44 cents in last year’s fourth quarter, but it will make the implication of the comparison ("They did that much better than last year?!") appear to say slightly more about the health of the economy than it should. It’s simply a quirk of the calendar. Don’t be lulled.

Moreover, thoughts on the national economy, always at the forefront when Gap reports, have been pushed further to the front, as on Thursday morning we got the revised release of 4th quarter 2012 GDP. At an anemic 0.1% growth rate, the number came in just ever so slightly above the first negative reading.

An overseas focus

But keep your focus – even if the media and traders do not – on Gap’s business overseas, where it has made big plans and promises but met with little success. Gap expects nearly a third of its revenue to come from overseas in 2013, but international sales dropped 3% in 2012. It is unclear when – or even if – Gap will succeed outside the confines of American malls. Stay tuned, even if Gap is told as a purely American story.

Keep an eye peeled, too, for another item likely to completely drop off the media’s radar when it covers Gap's earnings. In early January, when it reported its same-store sales for December, Gap announced plans for a $1 billion share buyback. The stock surged on the announcement, but too often, there’s little follow-up on these announcements by the media or analysts. How much have they bought back so far? Can anyone answer that?

Companies also will often make splashy buyback announcements but never actually get around to buying back the stock in a timely manner. It’s a good indication that Gap’s January announcement came on the heels of completing a separate $1 billion share program, but investors shouldn't trust – they should verify.

In this announcement Gap also unveiled the acquisition of Intermix – an online high-end women's clothing store – for $130 million in cash. This spoke again to a future filled with more than khaki and sweater combos.

Gap’s earnings will put a figurative punctuation mark on a week that saw earnings from a parade of retailers., including Target (TGT), Limited,(LTD), Kohl’s (KSS) Home Depot (HD), TJX (TJX), J.C. Penney (JCP) and Macy’s (M). All eyes are on J.C. Penney's stock Thursday morning; shares are tanking following the completion of one of the worst years in corporate history. Ouch.

Just remember, as the week grinds to a close, that Gap’s story isn’t as simple as their fashions. Come to think of it, even their fashions aren’t so simple anymore.

Marek Fuchs was a stockbroker for Shearson Lehman Brothers before becoming a journalist who wrote The New York Times' County Lines column for six years. Fuchs speaks regularly on business and journalism issues at venues ranging from annual meetings of the Society of American Business Editors and Writers to PBS to National Public Radio. His recent book, "Local Heroes: Portraits of American Volunteer Firefighters," earned widespread praise. He is on the writing faculty at Sarah Lawrence College. When Fuchs is not writing or teaching, he serves as a volunteer firefighter. You can contact him on Twitter: @MarekFuchs.

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