Gap Beats Q3 Earnings Estimate, Challenges Persist

Gap (GPS) posted better-than-expected fiscal 2019 third-quarter earnings results after the markets closed on November 21. However, as we expected, both its sales and earnings fell YoY (year-over-year), reflecting challenges in its base business.

Gap’s performance missed the mark despite its earnings beat. Robert J. Fisher, the company’s interim CEO, said, “We are not pleased with the third quarter results and are focused on aggressively addressing the operational issues that are hindering the performance of our brands.”

We think the challenges in the company’s base business are unlikely to abate soon and could continue to pressure its stock. Moreover, unrest in Hong Kong could continue to affect Gap’s business in the coming quarters.

Gap is struggling to lift its sales as a slump in traffic amid heightened competitive activity remains a drag. Moreover, the uncertain macroeconomic environment poses further challenges.

We think Gap’s margins are likely to take a hit from lower sales and promotions. Weak sales and margin contractions are likely to drag its earnings down in the coming quarters.

Gap’s third-quarter earnings in brief

Gap posted revenue of about $4.0 billion in the third quarter, down nearly 2% YoY. However, its revenue came in slightly ahead of analysts’ estimate. Its comparable sales fell 4%, with lower sales across all its brands.

Comparable sales of its Old Navy brand fell 4% in the third quarter. Comps fell 7% in the Gap brand and 3% in the Banana Republic brand in the quarter.

Gap posted a gross margin of 39.0%, which reflected a YoY contraction of 70 basis points. Meanwhile, its adjusted operating margin contracted 140 basis points to 7.5%. Weakness in the Old Navy brand remained a drag.

Gap’s bottom line stayed low, reflecting weak sales and margins. It posted adjusted EPS of $0.53 in the third quarter, which came in ahead of analysts’ estimate of $0.51. However, its earnings fell about 23% YoY.

Outlook

We expect the sluggishness in Gap’s sales and earnings to continue in the fourth quarter. Both its revenue and EPS could continue to decline despite growth in traffic during the holidays. Gap’s net sales in 2019 are likely to mark a low-single-digit decline. Earlier, management expected net sales to stay flat. Comps are expected to mark a mid-single-digit fall, down from the previous forecast of a low-single-digit decline.

The company expects its adjusted EPS to be $1.70–$1.75, down from its previous guidance of $2.05–$2.15.

A couple of analysts lowered their price targets on Gap stock following its third-quarter earnings release. Cowen cut its price target to $18 from $22, while Jefferies reduced its price target to $24 from $29. Gap stock is down about 37% year-to-date.