The fashion king has troubles, right here in Q1, with a capital "T" and that rhymes with "C," and that stands for comparable-store sales.
Let's get the disclaimers out of the way right at the start: Gap Inc.(NYSE: GPS) has a great brand, though it is not immune to the vagaries of fashion. Sales rise and fall, influenced by forces both in and out of the company's control. 1998 and the first two quarters of 1999 were very good at Gap, so it's only natural to expect a down cycle at some time.
Gap is in the throes of that cycle right now. Today's first-quarter earnings report contained some disturbing -- though not entirely unexpected -- elements. Sales rang in at $2.7 billion, 20% above last year's first quarter, but the number of stores has increased 22%, meaning that comparable-store sales, or comps, decreased 2%. The 31% increase in square footage over the year-ago quarter (including a number of store expansions) makes that revenue growth look even weaker. Net income of $235 million, or $0.27 per share, beat out last year's results by 16.4% and met analysts' estimates, according to First Call.
Investors knew about the decline in comps, since the numbers are released each month. That's the main reason why Gap has dropped over 30% this quarter.
Gap does a great job providing quite detailed information about its sales, which makes it possible to see some problem areas more clearly. Three times in the last four quarters comps have trended down at the eponymous domestic store. The slide in comps at Gap-brand domestic stores continued this quarter, falling in the mid-single digit range (for a definition of these ranges, click here), compared to a mid-single digit rise in comps a year ago.
Some of that weakness had previously been blamed on cannibalization by the lower-end Old Navy stores. That didn't hold true this quarter. After experiencing excellent comps in the mid-20s last year, Old Navy's comps actually declined in the low-single digit range this quarter. True, it was facing off against strong sales a year ago, but the drop is not encouraging.
Gap International and Banana Republic had positive mid-single digit comps this quarter. That's good, but not as strong as the mid-20s and low-double digits they respectively earned last year.
A lot of clothing retailers have had a tough year, but Gap's performance has trailed some of its main competitors. It's very tough to make an apples-to-apples comparison, since pure clothing retailers usually fill one niche or another, while Gap reaches many different groups. Still, here are monthly comps from American Eagle(Nasdaq: AEOS) and The Limited(NYSE: LTD) :
Feb. Mar. AprilAmerican Eagle 8.8 -0.3 5.8
Limited 6.0 4.0 14.0
Gap 4.0 -11 7.0
These competitors managed decent, positive comps for the quarter, while Gap did not. That's not a good sign.
With low comps naturally comes higher inventory. Gap's inventory levels rose 38% over the year-ago quarter. That's 7% higher than the 31% increase in square footage, boosting days inventory outstanding from 76 days to 87.5 days on an average quarterly basis. The company said that unexpectedly slow Easter sales, which came right at the end of the quarter, accounted for the increase.
Management said that aggressive markdowns have begun to clear the inventory out, but this selloff will adversely affect margins in the second quarter. That's the vicious cycle of retail: High inventory means not only slower cash flow, but also bigger markdowns, which hurt margins and sales of non-clearance items. Gap's margins don't need any more headaches, either. Higher wages and Web development costs helped to push operating margins down 50 basis points this quarter, in spite of lower advertising expenses.
Gap still feels that it is on track for the year. CEO Mickey Drexler acknowledged in the conference call that the company has skewed its focus too much toward teens, and that both Old Navy and Gap would begin to move away from cargo-pants styles to a better mix of young and adult "wear-to-work" looks in the third and fourth quarters. As a result, management expects comps to recover in the second half of the year, as it compares with the relatively weak part of 1999, and that the company can meet earnings estimates for the year.
That's good to hear, because investors will be keeping a close eye on inventory and comps. If trends don't improve, Gap will fall quickly out of fashion.
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