Gap Pinches Pennies

As it unveils its first quarterly report since the arrival of its new CEO, all eyes are on Gap (NYSE: GPS  ) . Investors may be psyched about Gap's first quarterly profit increase in recent memory, but I'd say the excitement will probably be short-lived. The retailer still has plenty of work to do, not to mention a few nagging questions.

Tightening the belt
Gap reported a 19% increase in net income to $152 million, or $0.19 per share. However, sales dropped 1% to $3.69 billion, and same-store sales decreased by 5%, atop a 5% decrease in the year-ago-period. Heartening news included a 130-basis-point increase in gross margin, to 34.3%, as the company lured consumers to pay more for merchandise. (Check out my Foolish colleague Rich Smith's Foolish Forecast to see how Gap stacked up to Wall Street's expectations.)

Obviously, the retailer has been cutting costs, most notably deciding not to proceed with its nascent Forth & Towne concept. In the conference call, Gap described additional cost-cutting initiatives, including headcount reductions, decreased marketing expenses, and reducing corporate office space by 16%.

Gap did increase its 2007 guidance to between $0.83 and $0.88 per share. (Last we'd heard, it expected $0.76 to $0.86 per share.) Although that improves upon reduced guidance from earlier this year, it's also not too far from Gap's original January 2007 guidance, which called for earnings of $0.83 to $0.87 per share. And it's a far cry from February's revised guidance of $0.89 to $0.91 per share. Gap seems to be treading water, and its back-and-forth moves on guidance seem to echo the uncertainty surrounding the company.

Furthermore, while it's certainly good that Gap's tightening its belt and aiming to become a more "nimble" company, you can only cut so many costs to boost profits. It's far more urgent for Gap to reverse its slumping sales trends. Amid an uncertain macroeconomic environment and tough competition, the company could face a rocky road ahead, however heartening its current progress.

Cashing in, cashing out
Gap's known for its impressive balance sheet, and many of its shareholders have been willing to forgive the company's growth shortcomings in light of its cash hoard. Gap currently has $2.7 billion in cash and investments -- roughly flat year over year. The company's free cash flow has been declining for years; Gap aims to generate at least $500 million in free cash flow this year, but even that figure's been whittled down from January's estimate of $650 million.

Right now, Gap is touting its $1.5 billion share repurchase plan, but it, too, carries some interesting caveats. The company's lowering its cash target from $1.5 billion to $1.2 billion, and it seems that part of the buyback will let some members of the founding Fisher family cash out. In the conference call, management revealed that it's buying shares from Fisher family members who own approximately 17% of Gap. The family and related entities currently own a total of 34% of Gap's shares.

Last month, I thought it was odd that the Fishers were handing over the chairman role to new CEO Glenn Murphy. Now, it also strikes me as a bit odd that the founding family appears to be cutting its stake in half. Are they getting the heck out of Dodge?

Is this brand-new outfit still out of fashion?
Glenn Murphy may not be a magic bullet, given his lack of experience in apparel retail. I think many Gap shareholders and observers hoped for a merchant CEO like former Gap head Millard "Mickey" Drexler, who now heads up J. Crew (NYSE: JCG  ) . Even giving Murphy the benefit of the doubt following his success at other retail ventures, I still can't see any quick turnaround ahead for Gap. Its shareholders have been thoroughly patient about the retailer's missteps for years now, and I think their wait's far from over.

A few promising retailers have suffered recent and likely temporary damage to their share prices, including American Eagle Outfitters (NYSE: AEO  ) , Chico's (NYSE: CHS  ) , and bebe (Nasdaq: BEBE  ) . All three have PEG ratios under 1.0, and even if some need a turnaround, their issues all seem fixable, and their troubles haven't persisted long enough to seriously tarnish their brands.

Gap, alas, had a strong brand, but I think those days are gone. Fools shouldn't underestimate the difficulty of rejuvenating battered brands, especially those suffering from years of bland, uninspiring merchandise.

Gap shares have never really looked cheap to me, despite the company's ongoing problems. Last time I checked, the stock was up more than 5% -- a decidedly uncautious sort of optimism. Given the company's continued uncertainty, some Gap shareholders might consider this a good time to take their money and run.

For related Foolishness, see the following articles:

Gap, American Eagle Outfitters, and bebe are Motley Fool Stock Advisor recommendations. Gap has also been recommended by Motley Fool Inside Value.

Alyce Lomax does not own shares of any of the companies mentioned. The Fool's disclosure policy is always in fashion.


Read/Post Comments (0) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 535389, ~/Articles/ArticleHandler.aspx, 9/16/2014 9:53:26 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 37 minutes ago Sponsored by:
DOW 17,131.97 100.83 0.59%
S&P 500 1,998.98 14.85 0.75%
NASD 4,552.76 33.86 0.75%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/16/2014 4:01 PM
GPS $44.12 Up +0.09 +0.20%
Gap CAPS Rating: ***
AEO $14.15 Up +0.68 +5.05%
American Eagle Out… CAPS Rating: **
BEBE $2.65 Down -0.03 -1.12%
Bebe CAPS Rating: *
CHS $15.56 Down -0.02 -0.13%
Chico's FAS, Inc. CAPS Rating: **
JCG.DL $0.00 Down +0.00 +0.00%
J. Crew Group, Inc… CAPS Rating: **

Advertisement