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Gap (GPS) Q2 Earnings Beat Estimates, Soft Comps Hurt Sales

Zacks Equity Research

The Gap Inc. GPS reported mixed second-quarter fiscal 2019 results, wherein earnings surpassed the Zacks Consensus Estimate but sales missed. Both the top and bottom line declined on a year-over-year basis.

Following the dismal top-line performance, shares of Gap dipped 1.2% in the after-hours trading session on Aug 22. The quarter also witnessed soft comparable sales (comps), with a decline across all brands, as well as lower margins.

Nevertheless, management reaffirmed the adjusted earnings and comps outlook for fiscal 2019. Moreover, this Zacks Rank #3 (Hold) company is committed toward inventory and cost discipline to drive results in the back half of fiscal 2019.

Q2 Highlights

In the fiscal second quarter, Gap’s adjusted earnings of 63 cents per share outshined the Zacks Consensus Estimate of 52 cents. However, the bottom line declined nearly 17.1% from 76 cents registered a year ago. On a reported basis, the company delivered earnings of 44 cents 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 dipped nearly 2% year over year to $4,005 million and also lagged the Zacks Consensus Estimate of $4,017 million. Foreign currency translations negatively impacted the top line by $22 million. Total comps were down 4% compared to 2% growth in the year-ago period.

Notably, comps declined 5% at Old Navy versus 5% improvement in the prior-year quarter. At the Banana Republic and Gap brands, comps declined 3% and 7%, respectively. In the year-ago quarter, comps rose 2% at Banana Republic and declined 5% at the company’s namesake brand.

Margins

Gross profit for the quarter under review decreased 4% to $1,556 million and gross margin contracted 90 basis points (bps) to 38.9%. Gross margin contraction can be attributed to a 70-bps decline in merchandise margin, mainly due to Old Navy, somewhat mitigated by the Gap brand.

Adjusted operating income declined 16.1% to $334 million and adjusted operating margin contracted 140 bps to 8.3%.

Financials

Gap ended the second quarter with cash and cash equivalents of $1,177 million, long-term debt of $1,249 million and total stockholders’ equity of $3,625 million.

During the first six months of fiscal 2019, the company generated net cash flow from operations of $583 million and incurred capital expenditures of $324 million. Gap had a free cash flow of $259 million as of Aug 3, 2019.

Coming to Gap’s shareholder-friendly moves, the company bought back 2.7 million shares for approximately $50 million and paid a dividend of 24.25 cents per share in the fiscal second quarter. Furthermore, the company announced a dividend of 24.25 cents per share for third-quarter fiscal 2019.

For fiscal 2019, management still 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.

For the rest of fiscal 2019, management continues to anticipate spending of about $50 million for share buybacks every quarter.

Store Updates

Gap opened 81 company-operated and 66 franchise stores, while closed 59 company-operated and 17 franchise stores in the first six months of fiscal 2019. Additionally, the company acquired 140 stores from Gymboree, Inc. related to Janie and Jack buyout on Mar 4. These outlets are included in the number of stores operated as of Aug 3, 2019.

Gap ended the fiscal second quarter with 3,877 outlets in 44 countries, out of which 3,356 were company-operated and 521 were franchise stores.

For fiscal 2019, Gap still anticipates to shut down nearly 30 company-operated stores, net of openings and repositions. The projection 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 remains committed toward store openings for Athleta, Old Navy and Gap China locations.

Outlook

Following Gap’s mixed second-quarter fiscal 2019 results, management updated the guidance for the fiscal year. The company still anticipates comps to decline in low-single digits. Moreover, it now estimates effective tax rate of roughly 30% compared with 27% guided earlier. Excluding certain non-cash tax impacts with respect to anticipated restructuring charges, the company continues to predict adjusted effective tax rate to be nearly 26%.

Furthermore, Gap now envisions fiscal 2019 earnings of $1.88-$2.08 per share compared with $2.04-$2.14 projected earlier. Gap continues to estimate its adjusted earnings per share in the range of $2.05-$2.15.


Price Performance

In the past three months, shares of Gap have lost 17.3% compared with the industry’s 24.4% decline.

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