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Specialty retailer Gap Inc. (NYSE:GPS) reported its Q3 results inline with the market expectations. [1] While the company had already reported a sales decline of 2% in its business update on November 3rd, gross margins were the major focus last week. Gap reported a decline of 4.5% in its margins due to increased promotions and increasing production costs. Though Q3 remained a disappointing quarter for Gap, the company was impressive with its preparations for the upcoming holiday season. Gap competes with other specialty retailers such as Abercrombie & Fitch (NYSE:ANF), Aeropostale (NYSE:ARO) and American Eagle Outfitters (NYSE:AEO)

Sequential declines in margins points to highly promotional nature of apparel market

While a decline in margins was expected for Q3, we were anticipating an increase in margins over Q2 banking on decline in cotton prices and Gap’s 21% increase in internet revenues, which carry higher margins than retail business. However Q3 margins stood 0.3% below that of last quarter which points to highly promotional nature of apparel market. Just a day before, rival Abercrombie & Fitch’s shares had crashed by over 15% primarily due to decline of 3.6% in margins because of heavy promotions.

(Chart created by using Trefis' app)

For the quarter ahead we expect the decline in margins to continue as Gap plans to set its comp sales right, especially for Old Navy, via promotions. Alongside the company’s holiday campaign is also built up around attractive promotional schemes, which may further impact the margins negatively.

(Chart created by using Trefis' app)

Gap looks geared up for next quarter

Despite a disappointing Q3, Gap is looking charged up for the next quarter. The company has kick-started a massive holiday campaign which features opening of 1000+ stores on Thanksgiving along with the launch of its holiday special site.

Apart from the holiday campaign, Gap is looking to expand its Athleta brand visibility in US with a new store opening in Minneapolis. Athleta has been going strong in US and we expect the company to open more of Athleta stores going ahead. On the international front, Gap remained positive about its China and Europe operations. The company plans to open 30 new stores in China along with the opening of factory stores in Europe.

We are revising our estimates slightly, which will be reflected on the site soon. The revision in our price estimate primarily reflects the changes made in company’s net cash/debt position.

Notes:

  1. Gap Inc. reports Q3 results, Source: Gap IR

Disclosure: None

Source: Gap Earnings Disappoint, Anticipating Holiday Push

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