Battered by negative comparable store sales growth, increased input costs and deep discounting, Gap Inc.‘s (GPS) third-quarter 2011 earnings of 38 cents per share declined 20.8% from the prior-period earnings of 48 cents per share. However, quarterly earnings managed to beat the Zacks Consensus Estimate by a penny. The impacts of negative forces on earnings per share were partially offset by the company’s massive share repurchases.
Quarter in Details
During the quarter, net sales edged down 1.9% to $3,585.0 million from $3,654.0 million in the year-ago quarter. Total revenue marginally missed the Zacks Consensus Estimate of $3,586.0 million.
Same-store sales slipped 5.0% for the quarter versus an increase of 1.0% in the prior-year quarter primarily due to negative double-digit comparable sales growth in the company’s women’s business. Gap reported a decline in same-store sales across all brands. Same-store sales of Gap North America, Banana Republic North America, Old Navy North America and International brands declined 6.0%, 1.0%, 4.0% and 10.0%, respectively.
Quarterly gross profit fell 12.7% year over year to $1,314.0 million, and gross margin contracted 450 basis points (bps) to 36.7%. Operating expenses, as a percentage of sales, leveraged 40 bps from the prior-year quarter to 27.0%. Gap’s operating income plunged 31.3% year over year to $346.0 million, while operating margin shriveled 410 bps to 9.7%.
Balance Sheet and Dividend
At the end of third quarter, the company has cash and cash equivalents of $1,392.0 million compared with $1,403.0 million in the year-ago period and free cash flow of $222.0 million.
In third-quarter 2011, the company deployed $645.0 million of cash toward share buybacks and $55.0 million toward dividends. Gap’s board of directors has authorized a new $500.0 million share repurchase program. During the quarter, Gap paid a quarterly dividend of 11.25 cents per share to its shareholders, up 13.0% from the prior-year period.
In the reported quarter, the company repurchased about 107 million shares for $2.0 billion.
Year-to-date, the company has made a capital expenditure of $416.0 million and expects to expend $575.0 million in Capex for fiscal 2011.
Store Count
During the reported quarter, Gap opened 41 company-operated stores and shuttered 29 locations, bringing the total company-operated store counts to 3,065. Moreover, in the third quarter, the company has opened 18 stores in franchise business while closed 2 stores bringing the total franchise store counts to 211.
In an effort to improve customer experience and enhance productivity per square footage, the company intends to strategically close and consolidate square footage at Gap and Old Navy brands. Gap wants to strategically reduce its Gap North America store counts to 950 by the end of fiscal 2013 including 700 specialty stores and approximately 250 outlets.
Contrary to this, the company is planning aggressively to expand its international and franchise business. The company intends to triple the Gap store count in China from 15 to approximately 45 during the next 12 month period. Moreover, the company is anticipating opening a total of 60 franchise stores by the end of fiscal 2011, of which it has already opened 33.
Guidance
The company has maintained its fiscal 2011 earnings guidance in the range of $1.40 to $1.50 per share. The current Zacks Consensus Estimate stood at $1.50 per share which at the higher end of guidance range.
Based in San Francisco, California, Gap is a premier international specialty retailer offering a diverse range of clothing, accessories, and personal care products for men, women, children and babies. Its flagship brands include Gap, Banana Republic, Old Navy, Piperlime and Athleta.
In a drive to boost international operations, Gap consolidated its foreign business under one division from London. Lackluster sales in North America compelled the company to explore business in other shores. In order to counter the domestic market saturation, Gap is aiming to generate 30% of total sales from its overseas operations and online business by 2013.
To achieve this end, Gap has opened its stores in China, Italy and Australia and has launched e-commerce business in more than 90 markets, which are expected to bolster its top and bottom line performance, moving forward.
Above all, Gap operates in a highly fragmented market and competes with national and local department stores and discount stores, such as American Eagle Outfitters Inc. (AEO) and The TJX Companies Inc. (TJX), which offer products at fire sale prices. To retain the existing market share, the company may have to slash sales prices, which could affect margins.
Gap’s shares maintain a Zacks #2 Rank, which translates into a short-term ‘Buy’ rating. Our long-term recommendation on the stock remains ‘Neutral’.
