Cost-cutting has become a patented move for U.S. clothes retailer Gap (NYSE: GPS). The company, which has been experiencing a general decline in sales since 2005, has managed to stay above water through cost-control measures. Despite its efforts, Gap is forced to downsize in the U.S. Let's see if Gap will be able to maintain its profitability.
Lean machine
Gap, which operates the brands Gap, Old Navy, Banana Republic, Piperlime, and Athleta, plans to reduce the number of stores to 700 in the next two years, a 21% cut across North America. All of the stores to be closed are under the Gap banner. The company is also planning to reduce the total square footage of its Old Navy brand stores by 1 million square feet. The moves are a part of the plan to reduce costs. For the first quarter of 2011, Gap's operating margins were 8.5%. However, after reducing the store counts, the retailer should have a good shot at returning to the 2010 operating margin of 13.4%.
Beyond these borders
While Gap is reducing exposure in the U.S., it's expanding operations in China. Expansion of flagship stores in foreign countries is an old strategy of American retailers. In China, the company expects to increase Gap stores from six to 45 by the end of 2012, and hit 400 franchise stores globally by the close of 2014.
Matters for concern
But while Gap tries to cut costs, it'll be important for it to remain profitable. Top-line growth is necessary for any organization, and Gap is certainly no exception. The company has been snowed under falling sales for years. September same-store sales fell 4% against the same period last year. This is worth noting at a time when peers Macy's (NYSE: M) and Target (NYSE: TGT) have reported rising same-store sales of 4.9% and 5.3%, respectively.
The main reason behind declining sales is the shift in consumer loyalty. Gap stores have become known for dull and neutral clothing, and cash-strapped consumers are not always willing to spend the extra money on a brand that falls between the high-end and discount segments.
Foolish bottom line
Cost-cutting measures can't always bail out Gap. Again, just opening new stores won't allow the company to boost sales organically. It must connect with consumers' needs and preferences. Until the company finds that connection, I'm staying away from the stock.
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