Gap (GPS -2.33%) managed to generate an unusual financial metric in the second quarter (which ended Aug. 1) when it announced a strong comparable store sales increase despite decreased overall sales. It also helped that the retailer's 18% sales drop was much milder than drops reported by other apparel and lifestyle retailers in their comparable quarters, including TJX Companies (down 32%), Nordstrom (down 53%), and American Eagle Outfitters (Q1 down 38%).

The 13% quarterly comps increase was fueled by strong digital demand, suggesting Gap was prepared to deal with the coronavirus pandemic and could put its efficient e-commerce program to the test. The struggling casual apparel chain enacted several tough changes leading up to the pandemic that helped turn around falling sales and the efforts paid off while customers clicked to buy.

As stores reopen, Gap is in a make-or-break moment. Will the progress last?

Gap employees wearing masks in store.

Image source: Gap.

Building brands that matter

Gap's sales have been underwhelming for several years, long enough to be alarming but minimal enough to allow for a series of actions intended to bring back growth. In the company's heyday, which was the 1990s into the early 2000s, Gap's various brands -- including Old Navy, Banana Republic, Athletica, Janie and Jack, and Intermix -- dictated casual styles and were the preeminent mall stores. But trends gradually moved toward cheap and chic, and Gap's basics seemed out of date. Customers also began to leave malls for boutique experiences, leaving Gap in a lurch. 

Gap went through a succession of leaders before landing with Art Peck, a longtime company insider who led the company's digital transformation in his five years on the job from 2015 to 2019. But while Gap has offered advanced omnichannel options for years, such as free shipping on many orders and pickup and return in many stores, customers still left for trendier styles and a more contemporary experience. Gap's various brands closed many stores to move away from malls and opened in better locations, but it was still saddled with most of its mall stores. This also affected the bottom line, as lower in-store sales couldn't justify the rents. The Gap brand in particular has struggled to find an identity and create a compelling message for customers. As recently as March, former CFO Teri List-Stoll said about the Gap brand, "Unclear brand positioning, poorly executed marketing messages and inconsistent product point of view continued to hinder overall performance."

After Peck's departure in November 2019, Gap appointed Sonia Syngal as the newest CEO in February 2020. Syngal was previously in the top job at Old Navy. Old Navy had for many years been Gap's biggest grower, and sales increased $1 billion in three years under Syngal's leadership. It also announced and then abandoned a plan to separate Old Navy into an independent, publicly traded company to unlock Gap's value.

Athleta, the company's women's athleisure brand, was the strongest Gap label over the past few quarters, as even Old Navy slowed down, facing tough competition from rivals such as Target and H&M (Hennes & Mauritz). This trend toward athleisure apparel has helped companies like Nike become the strongest U.S. apparel name and lulelemon athletica to massively expanded its operations. Athleta sales grew 6% in the second quarter, comps were up 19%, and digital sales increased by 74%.

Showing strength during the pandemic

A 95% online sales increase fueled the comps rise in the second quarter, and Gap's investment in digital channels and options paid off. It accomplished 50% online penetration, which is moving in the right direction as digital becomes more relevant. The company launched curbside pickup, buy online, and pick up in-store in tons of locations, and will introduce additional payment options like PayPal and Afterpay in the coming months.

Many customers discovered Gap for the first time, with 3.5 million new customers buying on the various brand websites this quarter, representing a 165% year-over-year increase. And as former buyers rediscover Gap, the company has a chance to remind its community why they loved it in the past. Going forward, the company expects to close 225 Gap and Banana Republic stores in 2020 and more in 2021.

Syngal made an interesting point when she said that the company's healthy position will let it "take share as the apparel market reshapes itself." Whatever the trends were prior to COVID-19, they're already changing because of the pandemic. For example, the trend away from business attire has accelerated and there is a strengthened focus on athletic wear, as exhibited by Banana Republic's poor performance and Athleta's win. This plays to Gap brand strength, which is in dress-down basics.

As to what else to expect in the third quarter, current CFO Katrina O'Connell noted that as stores reopened from May to June, the online year-over-year growth rate stayed strong, from 100% in May to 95% in June. And Gap is aiming to streamline its store fleet, keeping profitable stores and closing down others.

Gap stock has been steadily recovering since the March crash, and the price increased after the earnings release last week. Its performance is now close to flat for the year. It's probably not yet time to buy in, but if the company can keep up its e-commerce gains and push through the Gap and Old Navy brand recoveries, Gap might soon be on pretty solid ground.