The Gap: Earnings Preview

Aug.17.11 | About: The Gap, (GPS)

Gap Inc. (NYSE:GPS), one of world's leading premier specialty retailers, is scheduled to report its second-quarter 2011 financial results after the market closes on August 18, 2011. The current Zacks Consensus Estimates for the quarter is earnings of 34 cents a share. For the quarter under review, revenue is expected at $3,372.0 million, according to the Zacks Consensus Estimate.

First-Quarter 2011, a synopsis

Gap's first-quarter 2011 earnings of 40 cents per share declined 11.1% from last year's 45 cents, while the earnings came a penny ahead of the Zacks Consensus Estimate.

The drop in quarterly performance of the company was primarily attributable to sluggish top-line performance coupled with the rise in input cost.

During the quarter, net sales inched down 1.0% to $3,295.0 million from $3,329.0 million in the year-ago quarter. Same-store sales plummeted 3.0% for the quarter versus an increase of 5.0% in the prior-year quarter. Gap reported a decline in same store sales across all brands.

Guidance for Fiscal 2011

The company is apprehensive regarding the operating margin in 2011 owing to cost inflation. As a result, the company has lowered its fiscal 2011 earnings guidance in the range of $1.40 to $1.50 from its earlier expectation of $1.88 to $1.93 per share.

Second-Quarter 2011 Zacks Consensus

The analyst covered by Zacks expects Gap to post second-quarter 2011 earnings of 34 cents a share, slightly lower than earnings of 36 cents delivered in the prior-year quarter. The current Zacks Consensus Estimate ranges between earnings of 33 cents and 35 cents a share.

Zacks Agreement & Magnitude

Of the 27 analysts following the stock, 19 analysts revisited and upgraded their estimates, over the last 30 days for the second quarter of fiscal 2011. Consequently, the current Zacks Consensus Estimate increased by 4 cents to 34 cents, over the last 30 days.

However, over the last 7 days, not a single analyst has revisited their estimates and therefore, the current Zacks Consensus Estimate remains constant.

Positive Earnings Surprise History

With respect to earnings surprises, Gap has topped the Zacks Consensus Estimate over the last four quarters in the range of approximately 0.0% to 5.3%. The average remained at approximately 3.6%. This suggests that Gap has beaten the Zacks Consensus Estimate by an average of 3.6% in the trailing four quarters.

Our View

In a drive to boost its international operations, Gap seeks to consolidate its foreign business under one division from London. Lackluster sales in North America compelled the company to explore overseas market. 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 further strengthen its top- and bottom-lines performance, moving forward.

Further, in order to optimize its capital structure, Gap has entered into a new $500.0 million revolving credit facility maturing in 2016 with a syndicate of banks comprising BofA Merrill Lynch, Citigroup Global Markets and J.P. Morgan. The new credit facility will replace the existing $500.0 million revolving credit facility. Moreover, the company will get a five-year term loan facility of $400.0 million which will help in achieving its aim of expanding internationally.

However,Gap's business is seasonal in nature and generates a high proportion of sales during the fourth quarter, which is characterized by the crucial holiday season. Furthermore, the company ramps up its merchandise levels in anticipation of the season, exposing the company to significant risks, if the season fails to deliver expected operating performance.

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. (NYSE:AEO) and The TJX Companies Inc. (NYSE:TJX), which offer products at fire sale prices. To retain the existing market share, the company may have to reduce its sales prices, which could affect its margins.

Gap's shares maintain a Zacks #3 Rank, which translates into a short-term 'Hold' rating. Our long-term recommendation on the stock remains 'Neutral'.