Gap the Knife

Gap (NYSE: GPS  ) may have delivered a decent third-quarter profit, but there's still plenty for investors to beware in the quarterly results.

Net income increased 26% to $238 million, or $0.30 per share. That's the end of the good news. Elsewhere, sales were flat year over year, and comps decreased 5%, equaling last year's decline. Only Banana Republic increased its same-store sales -- just barely. Its comps increased 1% (compared to 3% this time last year).

New chairman and CEO Glenn Murphy highlighted the company's efforts to bolster earnings growth by managing inventory and paring expenses. Gap also increased fiscal 2007 guidance once again. Last quarter, it upped its outlook to $0.83 to $0.87 per share; now the company says it will earn $0.92 to $0.98 per share. That finally bests the guidance it put forth last February, when it expected earnings of $0.89 to $0.91 per share.

Gap's cash reserve has dwindled a bit; it now has $1.7 billion in cash, compared to $2.4 billion this time last year. However, for the first nine months of the year, it has managed to generate more free cash flow, at $484 million versus a year-ago $214 million. Its new guidance for $900 million in full-year FCF is definitely a good sign, beating last January's expectation of $650 million.

Gap's certainly making some progress, but tepid sales should give investors pause. You can only cut so much fat before you start hitting flesh and bone, and Gap still lacks the growth that investors long for. Murphy spoke enthusiastically about the company's merchandise, and won himself some brownie points for saying he'd worn the company's new "crazy stripe" sweater to the conference call.

Still, I'm not quite convinced. This company has needed a turnaround for ages, and yet the stock has never seemed cheap -- not to me, anyway. Shares have risen 10% in the last three months alone.

Compare Gap's trailing P/E of 20 with metrics from growth-happy stocks that look more like bargains now: American Eagle Outfitters (NYSE: AEO  ) at 12, Aeropostale (NYSE: ARO  ) at 17, and Abercrombie & Fitch (NYSE: ANF  ) at 16. For investors seeking retail-stock bargains, there are better places than the Gap to shop.

Shop around for some related Foolishness:

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