The Gap, Inc.'s (NYSE:GPS) January sales continued to show ongoing revenue challenges due to weak demand for the company's products. In short, comp sales were down across the three brands as GPS' poor response to new fashion continues to weigh on the company's sales prospects. The company guided for Q4 EPS of $0.56-0.57 vs. a consensus estimate of $0.53, but this is mainly due to cost-cutting, which is unsustainable, in my view.
A global comps decline of -8% vs. -9% last year was driven by Banana Republic (-17%), Gap (-6%) and Old Navy (-6%). Banana Republic remains the greatest concern for the company and its investors, as the brand continues to struggle to compete again "fast fashion" retailers such as Zara and H&M. In my view, Banana Republic is between a rock and a hard place: The brand faces competition in the entry-level luxury segment from Ralph Lauren (NYSE:RL) and Calvin Klein (CK), while getting squeezed in the low end with the aforementioned fast-fashion retailers gaining market share at GPS' expense.
GPS investors have to acknowledge that it will take some time for Banana Republic to regain its credibility after last year's leadership reshuffle. There are more near-term uncertainties that continue to overhang the stock, and GPS shares are best avoided until there is evidence of stabilizing comp sales. As an alternative to GPS, my preferred pick in the retail space is L Brands (NYSE:LB), which has seen have solid momentum in monthly sales growth in recent months. The company also recently increased its dividend by 20%. Within LB, Victoria's Secret is doing extremely well, while Bath and Body Works remains the preferred retail outlet for the type of products it sells.
Looking at the individual segments, Gap's flagship brand saw comps decline 6%, flat from the prior period. Old Navy, which had been holding on for the past several months, dipped into negative territory with a 6% decline. The most notable and worrisome miss was once again the Banana Republic brand, which saw a 17% decline in comp sales, driven by poorly designed offerings that clearly failed to connect with consumers.
The issue with Banana lies in its value proposition relative to those of Zara and H&M. A customer can achieve a higher value proposition with product quantity and quality at Zara than with the same outlay at Banana Republic.
Additionally, GPS' supply chain continues to lack competitiveness, and this has been negatively impacting the company's margins and sales. Although store closures and lower marketing spend may provide short-term support for earnings, it does not address the long-term revenue challenge. The structural changes in design process, inventory flow, and product pricing need to be addressed, and unless there is material improvement in those areas, investors can expect comps, margins, and earnings to deteriorate further.
In conclusion, I remain short GPS. As a switch-trade idea, I prefer L Brands.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.