Fool.com: Gangbusters at Gap (News) November 11, 1999

Gangbusters at Gap

By Richard McCaffery (TMF Gibson)
November 11, 1999

Apparel retailer Gap (NYSE: GPS) gunned its way to earnings of $315 million for the third quarter, up 32% from $238 million last year as the wide appeal of its Banana Republic and Old Navy stores kept consumers buying.

The San Francisco company reported earnings of $0.35 per share, up 30% from $0.27 per share last year and ahead of IBES International estimates by a penny.

Sales jumped 27% to $3 billion, up from $2.4 billion a year ago. Comparable store sales, one of the most useful ways for retail investors to judge customer demand for products, increased 5%, which is respectable considering last year's 13% increase.

Nevertheless, at a trailing price/earnings ratio around 30, the mighty Gap is priced as a growth stock and its stock suffers at the hint of weakness. Shares have fallen from more than $50 in July to around $34 today, a quick 32% drop largely on fears that the strength of its core Gap line is ebbing.

Shares fell about $3/8 in morning trading after the company reported that Q3 comparable store sales at Gap outlets declined, and sales at GapKids were flat. Both divisions faced tough comparisons with strong same-store sales growth last year.

That said, negative growth is always disappointing, and the company will have to remedy this weakness before investors are likely to bid up the shares. Meanwhile, Gap's lower priced Old Navy stores and higher priced Banana Republic divisions continue robust growth. Comparable store sales at these divisions slipped from last year's super-high marks, but Old Navy sales still grew in the low teens, and Banana Republic sales grew in the high single digits.

Is there any reason to think this company -- which has grown its stock about 32% annually since going public in 1976 -- has grown tired?

Don't think so. Fashion is a fickle business and it's not unusual for companies to experience weakness in various lines. Anyway, the diversification of its brands has helped Gap storm forward and that's what counts for shareholders -- the bottom line.

In terms of operations, Gap still looks better than an old pair of jeans. Gross margins for the quarter held firm at 43%, and net margins stayed constant at 10%. Some worry margins will erode as sales from lower-priced Old Navy stores become a bigger part of the mix, and it's worth factoring this into your long-term thinking about the stock. Maybe the company will have to work a little harder to earn a buck in the future, but the strength of the Old Navy concept is superb, and Banana Republic should help offset some of the difference.

Long-term liabilities grew to $1.2 billion, up from $811 million last year, largely as a result of the company's expansion plans, but debt as a percentage of shareholder's equity actually decreased to 0.63 from 0.65. Inventory levels increased 33% from a year ago, outpacing sales growth by 6 percentage points. This is worth keeping an eye on.

On the whole, a strong quarter from a company that has proven for years you never get tired of jeans, khakis, and T-shirts.

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