Why Is Gap (GPS) Down 14.3% Since Last Earnings Report?

A month has gone by since the last earnings report for Gap (GPS). Shares have lost about 14.3% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Gap due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important catalysts.

Gap Q2 Earnings & Sales Beat Estimates

Gap reported solid second-quarter fiscal 2018 results, wherein earnings and revenues surpassed the estimates and improved year over year. Notably, the company reverted to its positive earnings streak after a miss in the last-reported quarter, with the seventh consecutive sales beat. Further, management reiterated its guidance for the fiscal.

Q2 Highlights

In the fiscal second quarter, Gap’s earnings of 76 cents per share outpaced the Zacks Consensus Estimate of 72 cents. The bottom line also improved 31% from 58 cents registered a year ago. Quarterly earnings benefited from currency tailwinds of 2 cents per share.

Net sales grew 8% to $4,085 million and fared better than the Zacks Consensus Estimate of $3,985 million. Excluding the presentation changes, owing to the adoption of the new revenue recognition standard, the top line increased 4% year over year. These changes contributed $139 million to the top line. Also, foreign currency translations aided revenue growth by $23 million.

Total comps inched up 2% compared with 1% growth in the year-ago period. Notably, comps improved for the seventh straight quarter due to the continued strength at Old Navy and growth at Banana Republic. Comps for Old Navy and Banana Republic were up 5% and 2%, respectively, while comps for the Gap brand fell 5%.

Margins

Gross profit rose 10% to $1,627 million, with gross margin expansion of 90 basis points (bps) to 39.8%. Excluding the impact of presentation changes from the revenue recognition standard, gross profit increased 4% while gross margin contracted 10 bps to 38.8%, mainly due to the company’s flagship brand.

Further, operating income declined 11.8% to $398 million, with operating margin contraction of 220 bps to 9.7%. Excluding the impact of the revenue recognition standard, operating margin decreased 10 bps to 10.1%.

Financials

Gap ended the quarter with cash and cash equivalents of $1,322 million, long-term debt of $1,249 million and total stockholders’ equity of $3,340 million.

In the first half of fiscal 2018, the company generated net cash flow from operations of $546 million and incurred capital expenditure of $326 million. Gap had free cash flow of $220 million as of Aug 4, 2018.

For fiscal 2018, management continues to project capital expenditure of roughly $800 million. The amount will be used for transformative infrastructure investments to enhance its omni-channel platform, including information technology as well as supply chain capabilities.

Coming to Gap’s shareholder-friendly moves, the company bought back 3.2 million shares for approximately $100 million and paid dividends of 24.25 cents per share in the quarter under review. This dividend reflects more than 5% growth year over year. Additionally, management announced the fiscal third-quarter dividend of 24.25 cents per share, payable on or after Oct 31, 2018, to shareholders of record as of Oct 10. The company still had 385 million shares for repurchase at the end of the reported quarter.

Moving ahead, management continues anticipating share buybacks worth approximately $100 million per quarter through fiscal 2018.

Store Updates

While Gap opened 45 stores, including 34 company-operated and 11 were franchises, it shuttered 36 outlets in the reported quarter. The stores that were closed included company-operated and franchise locations of 18 each. Consequently, the company ended the fiscal second quarter with 3,626 outlets in 43 countries, of which 3,187 were company-operated and 439 were franchises.

In fiscal 2018, Gap still anticipates opening nearly 25 company-operated stores, net of closures and repositions. In sync with its growth strategy, the company expects to open more of Athleta and Old Navy stores and close down Gap and Banana Republic stores.

Outlook

Following the solid quarterly results, Gap reaffirmed its outlook for fiscal 2018. Comps are still anticipated to be flat to up slightly. Management continues to envision earnings per share of $2.55-$2.70.

Moreover, the effective tax rate for fiscal 2018 is still expected to be nearly 26%, owing to the impacts of the recent tax reform.

How Have Estimates Been Moving Since Then?

Fresh estimates followed a downward path over the past two months. The consensus estimate has shifted -5.51% due to these changes.

VGM Scores

At this time, Gap has a great Growth Score of A, a grade with the same score on the momentum front. Following the exact same course, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of A. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Gap has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.

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