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May 27, 2022

Gap shares plunge on eroding profitability, dimmer outlook

Gap lowers full-year earnings: US$0.40 to US$0.70 per share, below previous est. US$1.80 to US$2.05

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Gap Inc. sank after lowering its full-year forecast and posting first-quarter profit that missed Wall Street expectations due to operational missteps and higher costs.

The apparel retailer, which owns the Old Navy, Banana Republic and Athleta brands, posted a loss of 44 cents a share in the quarter ended April 30 -- below analysts’ average estimate. Full-year earnings, excluding some items, are now seen at 30 cents to 60 cents a share, which is well below the US$1.85 to US$2.05 range previously provided.

The shares fell 7.2 per cent at 9:44 a.m. in New York on Friday after briefly being halted for volatility. The stock has fallen 41 per cent so far this year.

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The results were especially surprising since Gap had cut its sales outlook barely a month ago, citing “execution challenges” at Old Navy, its biggest business. Thursday’s report showed that the Athleta brand is also performing well below expectations. And gross margin, a key measure of profitability, was 31.5 per cent in the quarter, below analysts’ average estimate of 35.3 per cent and down 930 basis points from a year earlier.

“After the company pre-announced weak top-line results on 4/21, many assumed we knew the bad news,” Citigroup analyst Paul Lejuez wrote in a note to clients. “But significantly weaker margins in 1Q, a miss at Athleta, and the magnitude of the guidance revision were even worse than market fears.”

Analysts worry there’s more bad news to come. Gap’s inventory levels jumped 34 per cent compared with last year. That has led to steeper discounts, especially at Old Navy -- already known for its low prices. The brand was plagued by size and assortment imbalances and delayed deliveries, Gap said. Old Navy’s net sales fell 19 per cent from a year earlier, while comparable sales plunged 22 per cent.

Total same-store sales, a key retail metric, fell 14 per cent in the quarter, while analysts had expected a decline of 9.9 per cent.

The quarterly results and bleaker forecast “reflect industrywide headwinds as well as challenges at Old Navy that are impacting our near-term performance,” Chief Executive Officer Sonia Syngal said in a statement. Higher costs and COVID-19 lockdowns in China also hurt profits. Gap expects performance to improve slightly in the second half of the year.

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Consumer companies are struggling to maintain profitability amid rising costs. Gap’s fuel and freight costs soared in the first quarter while higher prices pinched the wallets of low-income shoppers more than expected, prompting the company to discount bloated inventories. 

In an earnings call with analysts, Gap executives said mismanagement of the company’s plus-size line rollout hurt sales. The retailer said it overestimated demand for larger sizes, which was exacerbated by the lack of stock for core sizes due to supply-chain woes. Gap will continue to offer its plus-size line online but has cut a “significant portion” of extended sizes from orders for the third quarter. 

The brand will “monitor demand and refine as necessary,” Chief Financial Officer Katrina O’Connell said.

Upscale apparel chain Banana Republic stood out among Gap’s portfolio of brands, with same-store sales rising 27 per cent in the quarter as customers head back to offices and social events, Gap’s management said on the call. 

Shoppers turned away from Old Navy staples like active and leisurewear and fleece apparel in favor of khakis, work pants and dresses. The retailer also said it expects demand for occasion and office clothes to remain elevated for the rest of the year. 

The San Francisco-based chain was joined by American Eagle Outfitters Inc., which also cut its outlook for the full year after reporting first-quarter earnings that missed analysts’ estimates. American Eagle shares fell as much as 11 per cent on Friday.