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Why Gap’s Namesake Brand Hurt the Company’s Margins

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Gap brand drags down company-wide margins

As we discussed in the previous part of this series, Gap (GPS) failed to meet same-store sales expectations in the first quarter, largely due to a slump in demand for its namesake brand. The weaker-than-expected performance of the brand not only hit the company’s top line but also affected its margins.

The gross margin was down by 120 basis points after adjusting for accounting changes related to the adoption of ASC 606 (see the previous part of this series). 180 points of this fall came from a merchandise margin decline, which was partially offset by 60 basis point leverage from rent and occupancy costs.

The majority of the decrease in merchandise margins was due to higher promotional activity and aggressive inventory clearing at the Gap brand.

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Gap had reported six straight quarters of gross margin improvements before this quarter. The company’s strategic initiatives had been successful in driving its margins higher. Despite a weak quarter, Gap continues to have better profitability than other apparel retailers. The company’s trailing-12-month gross margin of 38.2% is more than Urban Outfitters’ (URBN) 32.8%, American Eagle Outfitters’ (AEO) 36.1%, and Guess’s (GES) 35.1%.

Guidance

Management reiterated its full-year sales and earnings guidance after the results. It continues to expect its sales comps to be flat or grow modestly for fiscal 2018. Earnings per share are projected to remain in the $2.55–$2.70 range, reflecting a 23% year-over-year increase at the mid-point.

“Despite the pressures we faced in the first quarter, we are affirming our full-year guidance, reflecting our confidence in the underlying fundamentals of the business as well as the benefits of executing against our balanced growth strategy,” said Teri List-Stoll, executive vice president and chief financial officer.

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