Gap's Shot Heard Round the World

| About: The Gap, (GPS)

Last week, The Gap (GPS – $18.88) delivered the “shot heard around the world.” The company disclosed that its GPM% would dramatically decline in response to product costs that were expected to increase +20% in the back half of the fiscal year. In addition, the company materially lowered its annual EPS guidance to $1.40 to $1.50 (versus $1.88 to $1.93).

Does anyone really believe that a large, (recently) sophisticated retailer like GPS woke up and realized that product costs would increase +20% in 2H 2011? Not us. The key question is why GPS would experience a much larger impact of higher sourcing costs than other less sophisticated specialty apparel retailers?

We’re willing to bet that there’s more to the story.

Did GPS management previously believe that shifting to more non-cotton material and adding fashion would allow for a mitigation of sourcing cost pressure? Sales in Q1 2011 may have proven that strategy wrong leading to broader, deeper discounting on lower-quality merchandise.

Therefore, is GPS management scrambling to shift back to a cotton dominated assortment and have they found themselves behind the 8-ball with last minute orders?

That our conspiracy theory and we’re sticking to it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.