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Gap (GPS) Down on Q1 Earnings & Sales Miss, FY19 View Cut

Zacks Equity Research

The Gap Inc. GPS reported dismal first-quarter fiscal 2019 results, wherein earnings and sales missed the Zacks Consensus Estimate and declined year over year. The dismal results mainly reflected soft top-line growth and comparable sales (comps) as well as lower margins. Furthermore, management lowered its earnings outlook for fiscal 2019.

The company also noted that the Trump administration’s recently announced intent to impose tariffs on clothing goods produced in China may impact results going forward. Gap stated that its current guidance incorporates impacts from List 3 goods but does not include any potential tariff impacts from List 4 goods.

Following the dismal quarterly results, soft outlook and uncertainty surrounding the impacts from tariffs, shares of Gap decreased significantly in the after-hours trading session on May 30. In the past three months, this Zacks Rank #3 (Hold) stock has lost 27.3%, wider than the industry’s 25.6% decline.



Q1 Highlights

In the fiscal first quarter, Gap’s earnings of 24 cents per share missed the Zacks Consensus Estimate of 31 cents. The bottom line also declined nearly 42.9% from 42 cents registered a year ago. Quarterly earnings included currency tailwinds of 1 cent per share.

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 declined 2% year over year to $3,706 million and also lagged the Zacks Consensus Estimate of $3,756.2 million. Foreign currency translations negatively impacted revenues by $34 million. Total comparable sales (comps) were down 4% compared to 1% increase in the year-ago period. The decline is attributed to soft comps performance across all brands.

Like most in the industry, Gap witnessed soft top line and comps due to extremely cold and wet weather that resulted in a slow start to business in February. Although traffic and business picked momentum in March and April, it was difficult to overcome the softness encountered in February.  Additionally, late spring breaks, a shift in Easter as well as a delayed and lower tax refunds impacted the top line.

Notably, comps declined 1% at Old Navy versus 3% improvement in the prior-year quarter. At the Banana Republic and Gap brands, comps declined 3% and 10%, respectively. In the year-ago quarter, comps rose 3% at Banana Republic and declined 4% at the company’s namesake brand.

Margins

While gross profit fell 6% to $1,344 million, gross margin declined 140 basis points (bps) to 36.3%. Gross margin contraction can be attributed to a 120 bps decline in merchandise margin coupled with a 20 bps rent and occupancy deleverage owing to lower sales.

Adjusted operating income declined 43.2% to $130 million, while adjusted operating margin contracted 260 bps to 3.5%.

Financials

Gap ended the quarter with cash and cash equivalents of $941 million, long-term debt of $1,249 million, and total stockholders’ equity of $3,571 million.

In the fiscal first quarter, the company generated net cash flow from operations of $29 million and incurred capital expenditures of $165 million. Gap had negative free cash flow of $136 million as of May 4, 2019.

Coming to Gap’s shareholder-friendly moves, the company bought back 1.9 million shares for approximately $50 million and paid a dividend of 24.25 cents per share in the fiscal first quarter. Furthermore, the company announced a dividend of 24.25 cents per share for second-quarter fiscal 2019.

For fiscal 2019, management now projects capital expenditures of roughly $675 million that comprises $100 million of expansion charges associated with one of its headquarters buildings as well as the development of the Ohio distribution facility. Earlier, the company had anticipated capital expenditure of $750 million for the fiscal year.

In fiscal 2019, management anticipates spending $200 million for share buybacks, with about $50 million buybacks every quarter.

Store Updates

Gap opened 37 company-operated and 46 franchise stores, while closed 36 company-operated and four franchise stores in the quarter under review. Additionally, the company acquired 140 stores from Gymboree, Inc. related to Janie and Jack on Mar 4. Net of the company’s store openings and closings as well as the assets acquired from Gymboree, Gap ended the fiscal first quarter with 3,849 outlets in 43 countries, of which 3,335 were company-operated and 514 were franchise stores.

In fiscal 2019, Gap now anticipates to shut down nearly 30 company-operated stores, net of openings and repositions. This revised projection comprises about 10 additional store opening for both Old Navy and Athleta. The guidance also includes closing 130 stores related to the restructuring of the Gap brand fleet. However, most of these stores are expected to be closed in fourth-quarter fiscal 2019. Simultaneously, it expects store openings to be more focused on Athleta, Old Navy and Gap China locations.

Outlook

Following Gap’s soft first-quarter results, management lowered its earnings and comps guidance for fiscal 2019. The company anticipates comps to be down low single digits compared with the prior projection of flat to up slightly. Moreover, it estimates effective tax rate of roughly 27%. Excluding certain non-cash tax impacts related to expected restructuring charges, the company predicts adjusted effective tax rate to be about 26%.

Consequently, Gap now envisions earnings per share of $2.04-$2.14 for the fiscal year compared with $2.11-$2.26 expected earlier. Adjusted earnings are estimated to come in at $2.05-$2.15 versus the prior projection of $2.40-$2.55.

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Zumiez Inc. ZUMZ has a long-term earnings growth rate of 13.5% and a Zacks Rank #2.

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