Gap (GPS) beat analyst expectations on both revenue and profit in its latest fourth quarter results. David Swartz, Equity Analyst at Morningstar, joins Yahoo Finance Live to discuss the company's performance and the wider retail landscape.
Swartz notes that "most of the benefit" from Gap's earnings report stemmed from "greater-than-expected" gross margins. However, Swartz believes Gap's stock is "undervalued," adding that he plans to revise his rating upwards as the company proves itself to be "stable" despite headwinds.
Amid sales numbers that are "still not strong," Swartz suggests that the new CEO, Richard Dixon, provides hope for a turnaround and improved margins. He warns that Dixon "has his work cut out for him."
Swartz stresses that the company's focus needs to be on Old Navy, as the brand "generates the vast majority of its operating income."
For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.
Editor's note: This article was written by Angel Smith
Video Transcript
JOSH LIPTON: Gap out with its fourth quarter earnings. Shares are jumping after the retailer beat on the top and bottom lines. With more on this and the wider retail landscape, let's bring in David Swartz, Morningstar Equity Analyst. David, it's good to see you. So listen, Gap reports, investors like what they see. This stock is surging about 10% right now in the after-hours, David. But give us your reaction. What did you make of the report?
DAVID SWARTZ: The earnings per share are above the expectations was at $0.25 and Gap reported $0.49, so I think that explains why the stock is up. It looks like most of the benefit came from the gross margin. I did anticipate gross margin improvement, but it looks like it was even greater than expected, up about 5 points from last year when it was quite depressed.
The sales numbers, a little bit better than I expected. But certainly nothing to get excited about. Old Navy just had a 2% same-store sales growth number, which is pretty weak considering last year's fourth quarter was very poor for Old Navy. But you know, I think the stock has been undervalued. I've had it valued in the mid-20s. You know, I may revise that after we hear more from the company later today.
But, you know, I had the company-- had had the stock is undervalued for some time. And I think it's a good value. And I think people are starting to see that. Gap is really stable, although it's a troubled company.
JULIE HYMAN: And so when you look at something like the gross margin, for example, which the company attributes the improvement to lower air freight expenses, improved promotional activity, and also better rent costs, doing better on that front, presumably, you think there's some more wood to chop there, though, right? So what levers can the company still pull?
DAVID SWARTZ: Yeah. I mean, partly it comes down to sales growth. The sales numbers are still not strong. And that does affect the expenses, because the operating expense then right now is not at the right level for the sales. And so as the sales increase, the company will get some expense leverage on occupancy, as you mentioned, and other factors, because right now, it's not really operating at peak level.
So you know, I think that there is some ability to improve the margins, but we have seen improvement from really low numbers, to be honest. Still, a 5% operating margin is nothing to be excited about for this company. I do think it will go higher in future years, especially as Old Navy has higher margins than Gap's other brands. But it really depends on how Old Navy develops.
JOSH LIPTON: And David, a quick question as well about the CEO. You know, Richard Dixon is fairly new on the job. So what so far do you make of the job he's doing?
DAVID SWARTZ: Yeah. It's only been a couple quarters since he took over. But certainly, he's revitalized, you know, I think, parts of the company. We haven't really seen the numbers so much yet. But of course, it's still early. I think it provides some hope.
But the reality is that Gap has been sort of a revolving door of CEOs for the past 20 years since Mickey Drexler was fired. And so it's really a tough job. And it's a job that others have failed at. And so Richard Dixon has his work cut out for him. So we'll see what happens.
JULIE HYMAN: David, you said-- it sounds like you think the most important thing here is to improve the sales. How does he do that, right? Like, is it-- is it just getting the style right? And how does-- you know, obviously, in retail, that's a really tough thing to do. How do you think they get there?
DAVID SWARTZ: Yeah. I mean, to be more specific, it's really the sales at Old Navy, because Old Navy generates most of Gap's revenue and the vast majority of its income. Gap doesn't give us the specific numbers, but I'm sure that Old Navy generates the vast majority of its operating income.
So and Old Navy has been troubled. It's had a series of problems. They've had merchandising problems. They tried some new styles and including new sizes. And that strategy didn't really work. It was partly because a lot of things were delayed by the shipping problems that came out of the pandemic. And you know, so I think that some of the merchandising issues are starting to get fixed.
But there is some concern that I have that Gap has lost customers at Old Navy that may not be coming back, because Old Navy has really been struggling for some time now. And there's so many other options out there, including new companies relatively, new companies like Shein, for example, that really are targeting the same Old Navy shopper. And so there has to be some concern that the Old Navy customers may not be coming back.
JULIE HYMAN: Yeah. Really interesting stuff, David. Thank you so much for your perspective on Gap. Appreciate it.
