Gap (GPS 1.07%) posted its second-quarter earnings report on Aug. 25. The apparel retailer's revenue declined 8% year over year to $3.86 billion, but still cleared Wall Street's estimates by $40 million.
Its comparable store sales fell 10%, as its 8% comps growth at Banana Republic failed to offset a 15% drop at Old Navy, a 7% decline at Gap, and an 8% slump at Athleta. Its adjusted net income tumbled 89% to $30 million, or $0.08 per share, but still beat the consensus forecast by a dime.
Image source: Getty Images.
Those growth rates were dismal, but the market's expectations for Gap had already been tempered following CEO Sonia Syngal's abrupt departure last month. Syngal, who took the helm in early 2020, launched a "Power Plan 2023" turnaround strategy to reboot Gap's core businesses, but its recent growth rates indicated it would broadly miss those targets.
That's why it wasn't surprising when Gap withdrew its previous full-year guidance, which had called for a low- to mid-single-digit revenue decline with a 58% to 79% drop in its adjusted earnings per share. It didn't provide any new estimates, but analysts expect its revenue and adjusted EPS to decline 6% and 99%, respectively for the full year.
Those downbeat expectations indicate that Gap's stock could remain out of favor for the foreseeable future. But should bold value-seeking investors still consider buying Gap's stock for its hefty forward dividend yield of 5.9%?
NYSE: GPS
Key Data Points
Can Gap's core banners recover?
Gap splits its business into four banners: Old Navy (which generated 54% of its second quarter sales), Gap (23%), Banana Republic (14%), and Athleta (9%). Under Syngal, Gap aggressively shuttered its weaker Gap and Banana Republic stores while expanding its Old Navy and Athleta banners. Here's how those four banners fared over the past year.
|
Metric |
Q2 2021* |
Q3 2021* |
Q4 2021* |
Q1 2022 |
Q2 2022 |
|---|---|---|---|---|---|
|
Old Navy comps growth (YOY) |
18% |
6% |
0% |
(22%) |
(15%) |
|
Gap comps growth (YOY) |
3% |
3% |
3% |
(11%) |
(10%) |
|
Banana Republic comps growth (YOY) |
(5%) |
(10%) |
(2%) |
27% |
8% |
|
Athleta comps growth (YOY) |
27% |
41% |
42% |
(7%) |
(8%) |
|
Total comps growth (YOY) |
12% |
5% |
3% |
(14%) |
(10%) |
Data source: Gap. YOY = Year over year. *Relative to 2019 (pre-COVID-19).
Gap's comps growth seemed to stabilize across all four banners in fiscal 2021 (which ended in January 2022), when it set its pre-pandemic sales in 2019 as its baseline instead of its pandemic-induced closures throughout 2020. It also seemed like it could count on Athleta, which competes against Lululemon Athletica in the high-end yoga apparel and activewear market, to offset the slower growth of its other three banners.
But this year, Gap's comps growth abruptly declined across its Old Navy, Gap, and Athleta banners. It blamed that slowdown on inflationary headwinds, supply chain disruptions, inventory delays, sluggish sales in China, and various size and assortment problems. The only bright spot was Banana Republic, which benefited from the brand's relaunch last year.
Rising inventories and declining gross margin
Gap's inventories rose 23% in 2021, then increased another 34% and 37% year over year in the first and second quarters of 2022, respectively. Its inventory levels were climbing so quickly that it needed to write off $58 million in "unproductive" inventory, primarily at Old Navy, in the second quarter.
To stabilize its comps growth and reduce its inventories, Gap will likely need to resort to margin-crushing markdowns. Gap's gross and operating margins have already declined significantly year over year in the first half of 2022, and additional markdowns will severely exacerbate that pressure.
|
Metric |
Q2 2021 |
Q3 2021 |
Q4 2021 |
Q1 2022 |
Q2 2022 |
|---|---|---|---|---|---|
|
Gross margin |
43.3% |
42.1% |
33.7% |
31.5% |
34.5% |
|
Operating margin |
9.7% |
3.9% |
0.2% |
(5.7%) |
(0.7%) |
Data source: Gap.
If those headwinds persist, Gap will likely need to reduce or suspend its annual dividend of $0.60 per share, which is on track to eclipse its estimated earnings of just $0.02 per share this year.
Gap's tumbling profits have also made its stock more expensive. It now trades at 35 times forward earnings, while Abercrombie & Fitch and American Eagle Outfitters only trade at nine and 10 times their forward earnings estimates, respectively.
There's no reason to buy Gap right now
Gap's growth is decelerating, its inventory levels are soaring, its margins are contracting, and it desperately needs a new CEO. The retail apparel sector is already a hostile environment as inflation throttles consumer spending, so it doesn't make sense to buy a laggard like Gap when even its stronger competitors are struggling to stay afloat.
