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Gap (GPS) Beats Q1 Earnings & Sales Estimates, Raises View

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The Gap Inc. GPS reported better-than-expected top and bottom-line numbers for first-quarter fiscal 2021. Also, its earnings and sales improved year over year. Moreover, it reported strong growth in key metrics on a two-year basis (compared with first-quarter fiscal 2019), reflecting robust growth from the pre-pandemic levels.

In the fiscal first quarter, the company’s earnings of 48 cents per share beat the Zacks Consensus Estimate of a loss of 2 cents. Moreover, earnings per share improved substantially from a loss of $2.51 in the year-ago quarter and adjusted earnings of 24 cents reported in first-quarter fiscal 2019.

Net sales improved 89% year over year and 8% from the 2019 pre-COVID levels to $3,991 million and surpassed the Zacks Consensus Estimate of $3,538 million. The top line has been benefiting from strength in its Old Navy and Athleta brands, growth in the Gap business in North America, and market share gains.

Further, the reopening of the majority of stores is aiding sales. Despite the opening of stores, the company continued to witness strength in the online business, with digital sales increasing 61% year over year and 82% from the first quarter of fiscal 2019. Notably, digital business contributed 40% of total sales in the reported quarter.

The Gap, Inc. Price, Consensus and EPS Surprise

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

Further, the company continued to witness strong growth in active and fleece categories along with a resurgence in summer fashion, with a rebound in dresses, as consumers continued to blend comfort with style ahead of the spring season.

However, the company is not yet free of COVID-related impacts as international markets like Canada, Europe, China, and Japan continue to be under the radar of rising cases. Gap notes that the COVID-related impacts hurt sales by 2% from the 2019 period. Also, the company’s top line witnessed impacts of nearly 5% versus the 2019 period, driven by permanent closures in the Gap and Banana Republic brands as part of the Power Plan 2023 strategy.

Consolidated in-store sales declined 16% from first-quarter fiscal 2019, driven by permanent store closures as part of the Power Plan 2023 strategy and COVID-related closures outside the United States.

Comparable sales (comps) rose 28% year over year and 13% from first-quarter fiscal 2019. Comps included online sales as well as the comparable sales days for stores that were open on the same days in both the 2020 and 2019 comparable periods.

In the past three months, shares of this Zacks Rank #3 (Hold) company have gained 37.3% compared with the industry’s 1.2% growth.

Brand-wise Sales & Comps

In first-quarter fiscal 2021, net sales declined 16% and 29% at Gap Global and Banana Republic Global brands, respectively, from first-quarter fiscal 2019. Further, comps for Gap Global and Banana Republic Global were down 1% and 22%, respectively, on a two-year basis.

Meanwhile, sales improved 27% and 56% for the Old Navy and Athleta brands, respectively, from the pre-pandemic levels. Comps at Old Navy Global and Athleta increased 25% and 46%, respectively, from the 2019 comparable period. On a year-over-year basis, comps improved 29%, 35% and 27%, respectively, at Gap, Old Navy and Athleta brands, while it was down 4% for Banana Republic.

At the Old Navy brand, sales gained from the continued momentum in casual and cozy categories, with sturdy performance in active and fleece. Also, it witnessed a rebound in seasonal categories as consumers move to the pandemic recovery phase, planning vacations and summer activities.

Athleta reported exorbitant digital growth, which increased 113% from the first-quarter fiscal 2019 levels. Growth was driven by robust regular-priced sales, led by gains in relevant categories and purpose-led marketing. It also benefited from the launch of inclusive sizing and partnership with Simone Biles in the reported quarter.

Furthermore, The Gap brand witnessed robust trends in its North America business, which delivered comps growth of 9% on a two-year basis. The company is likely to further expand The Gap brand’s reach through the latest and exclusive Gap Home distribution agreement with Walmart.com.

Meanwhile, transformation at the Banana Republic brand is underway, as redefining casual luxury and enhancing creativity remain priorities. The company benefited from showcasing floral windows at its stores to welcome spring. Further, it looks to gain from uplifting emerging designers through its newly launched capsule collection with Prep Curry, which received positive customer responses.

Margins & Costs

Gross profit of $1,630 million reflected a substantial increase from $268 million in the prior-year quarter and improved 21% on a two-year basis. Gross margin of 40.8% expanded 450 basis points (bps) from first-quarter fiscal 2019, backed by 430-bps leverage from lower rent and occupancy costs stemming from online growth, store closures and negotiated rent.

Also, gross margin benefited from a 20-bps expansion in merchandise margins, driven by strong product acceptance, which led to lower discounts. Favorable merchandise margins offset 200 bps of headwinds related to higher shipping costs linked to growth in online sales.

Adjusted operating expenses declined 11.7% year over year but increased 9.9% on a two-year basis to $1,334 million. The increase in operating expenses can be attributed to higher marketing investments, which led to 0.9 points market share expansion. Adjusted operating expense rate of 33.4% increased 60 bps from 32.8% in first-quarter fiscal 2019.

Moreover, adjusted operating income of $296 million increased substantially from a loss of $1,244 million in first-quarter fiscal 2020 and adjusted operating income of $130 million in first-quarter fiscal 2019. Adjusted operating margin of 7.4% expanded 390 bps from 3.5% in first-quarter fiscal 2019.

Other Financials

Gap ended the fiscal first quarter with cash, cash equivalents and short-term investments of $2,541 million, representing substantial growth from $1,079 million in the year-ago period. As of May 1, 2021, it had total stockholders’ equity of $2,806 million and long-term debt of $2,218 million.

In first-quarter fiscal 2021, the company generated free cash flow of $216 million compared with a negative free cash flow of $1,062 million in the year-ago period due to COVID-related impacts.

In first-quarter fiscal 2021, the company paid out its previously deferred first-quarter fiscal 2020 cash dividend of 24.25 cents. Additionally, it declared a second-quarter fiscal 2021 dividend of 12 cents on May 11.

The company also plans to resume its share repurchase program to reward shareholders. Currently, it has $800 million remaining under its $1-billion share repurchase authorization. It expects to repurchase shares worth up to $200 million under its current program through the rest of fiscal 2021.

For fiscal 2021, the company anticipates capital expenditure of $800 million.

Store Update

As of May 1, 2021, The Gap had 3,571 stores in more than 40 countries, out of which 2,997 were company-operated and 574 were franchise outlets.

In fiscal 2021, the company plans to close about 75 Gap and Banana Republic stores in North America. It also expects to open 30-40 Old Navy and 20-30 Athleta stores.

Fiscal 2021 Guidance

Backed a strong start to fiscal 2021, led by robust sales growth and operating margin expansion from first-quarter fiscal 2019, Gap raised its view for fiscal 2021. It now envisions adjusted earnings of $1.60-$1.75 per share compared with $1.2-$1.35 mentioned earlier. GAAP earnings per share are now expected to be $1.55-$1.70. The company expects year-over-year sales growth in the low-to-mid twenty percent range compared with mid- to high-teens stated earlier. The company’s sales guidance includes revenues lost due to the divestitures of Janie and Jack, and Intermix, which are expected to be 2% of annual company sales.

Moreover, the company expects reported and adjusted operating margin of 6%, up from 5% mentioned earlier. The updated view is driven by strong fiscal first-quarter performance and the company’s progress on achieving its targeted 10% operating margin rate by 2023, in sync with its Power Plan 2023. It anticipates adjusted effective tax rate of 25% for fiscal 2021. Interest expenses are likely to be $210 million.

At the end of second-quarter fiscal 2021, the company anticipates inventory growth of high-single digits to mid-teens compared with the year-ago quarter. Higher inventory levels are mainly attributable to increased in-transit inventory, owing to continued supply-chain challenges, which are resulting in port congestion and longer lead times.

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