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3 Takeaways From Gap's Q2 Earnings

By Pearl Wang – Aug 31, 2020 at 2:23PM

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Gap's second-quarter earnings report is showing a recovery from recent lows. Here's what's driving its revenue pickup.

Clothing retailer Gap (GPS 0.68%) reported second-quarter earnings late last week which included a per share of a loss of $0.17 on revenue of $3.3 billion, beating consensus projections of a loss of $0.41 on revenue of $2.9 billion. Revenue was down 18% year over year, hurt by a period of store closures in the quarter that were related to the COVID-19 pandemic. Revenue strength in digital sales, as well as the Athleta and Old Navy brands helped offset some of the overall sales drop.

Here are three takeaways from the second-quarter report and what it might say about the stock as an investment.

Displays at a Gap store

Image source: Gap.

1. Old Navy and Athleta were bright spots in the quarter

The Old Navy segment performed very well in the second quarter, as consumers resonated with its active, lounge, kids, and baby products. Shoppers apparently appreciated the on-trend merchandise at value prices. While net sales were down 5% in Q2 due to a four- to six-week period of massive store closures, online sales increased 136%.

CEO Sonia Syngal spoke of Old Navy's strong revenue growth in the quarter on the earnings call: "With net sales down 5%, considering stores -- the majority of the fleet was closed for -- in the range of four to six weeks, it's really impressive results, and it shows the strength of the brand and the momentum that built as the quarter progressed."

Another strong segment in Q2 was Athleta, where revenue was up 6% in Q2, driven by a 74% increase in online sales. As consumers socially distanced and spent more time at home, they gravitated toward athleisure and lounge wear, which comprise a large portion of Athleta's merchandise.

Gap sees more opportunity to gain share and grow Athleta's presence in the market. CFO Katrina O'Connell believes Athleta is at only about 50% brand awareness and has the opportunity to open more stores. Athleta's marketing message around female empowerment is resonating with its audience, Syngal said, helping to boost brand recognition.

2. The digital business was a good driver of the recovery

Revenue in the second quarter for the consumer discretionary company was boosted by strong performance in digital revenue, with a 95% increase year over year. During the quarter, Gap added an impressive 3.5 million new customers to its e-commerce base.

"Through a focus on digital marketing investments, the team unlocked significant momentum in new customer acquisition during the quarter," Syngal said on the call.

The retailer has some confidence that the strength will continue in the second half of the year, noting "meaningful online sales growth" during the current quarter. This will be boosted by strategic marketing efforts in brands, with Old Navy's message already proving particularly successful. Old Navy's marketing message of trend-right fashion in the value space resonated with customers. Gap is also adding two payment options for online shopping, PayPal and Afterpay, in the fall, to make transactions easier.

Gap's curbside pickup and buy online, pick up in-store offerings that started in Q2 are capturing more sales, with rollouts at over 1,500 stores. "Of our 1.8 million multichannel customers in Q2, 30% of them had only shopped with us in one channel prior to this," Syngal said.

3. Gap has a reasonable balance sheet

The company ended the quarter with $2.2 billion in cash. It has a debt ratio of 0.83, indicating a reasonable amount of debt. This, along with the recent recovery in revenue, will help Gap manage through the current economic volatility.

Gap sees capital expenditures of about $300 million for the full year, with much of it going toward supply chain and technology investments. This will allow the company to continue its revenue growth in digital sales. The retailer is also working on over 225 store closures, including potential lease negotiations, which could lead to savings.

Overall, Gap is exhibiting a decent recovery from its trough earlier this year. With about 90% of global stores reopened (as of Aug. 1), a strong digital and omnichannel strategy, and ongoing revenue growth at Athleta and Old Navy, it looks like Gap is positioned to survive the ongoing economic uncertainty.

Pearl Wang has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends PayPal Holdings and recommends the following options: long January 2022 $75 calls on PayPal Holdings. The Motley Fool has a disclosure policy.

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