- Gap's quarterly revenue fell 5% Y/Y. Old Navy, its largest brand, remained a stalwart.
- Online revenue increased 54%, proving the company's digital platform can compete.
- Inventory grew, despite the decline in revenue. Inventory could remain elevated until the economy fully reopens.
- GPS remains a hold.
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The Gap, Inc. (NYSE:GPS) reported revenue of $4.42 billion, Non-GAAP EPS of $0.28 and GAAP EPS of $0.61. The company missed on revenue, yet beat on earnings. GPS is up in the high-single-digit percentage range post earnings. I had the following takeaways on the quarter.
Gap's Top Line Continues To Falter
COVID-19 practically caused business activity to ground to a halt in the first half of 2020. Retailers with a bricks-and-mortar strategy were forced to temporarily close stores to help stem the spread of the pandemic. In August, most of Gap's stores were reopened. However, the knock-on effects of COVID-19 still linger. The company has plans to reduce as many as 350 stores in order to make its physical locations more efficient. Gap may have to as more and more purchases are being made online.
For the quarter-ended January 2021, Gap's $4.4 billion in net sales fell 5% Y/Y.
Old Navy, Gap's largest segment, fell 5% Y/Y. Gap Global and Banana Republic Global each fell in the double-digit percentage range. Old Navy experienced 7% comparable sales growth in the face of store closures and operating restrictions due to COVID-19. It may have helped that over 90% of Old Navy's revenue was derived from the U.S. Several European countries re-instituted lockdowns during the quarter to combat the coronavirus; Old Navy was largely able to avoid these headwinds.
Revenue from Gap Global fell 19%, while comparable sales were down 6%. The Gap brand was negatively impacted by COVID-mandated store closures and restrictions in Canada, China, Europe and Japan. Banana Republic's sales and comparable sales both fell in the double-digit percentage range. The brand has struggled with providing the right mix of assortments to meet consumer demands.
Old Navy represented 54% of total revenue, up from 48% in the year-earlier period. This is the one brand that is growing, so its outsized influence is a positive for the company. The Gap brand is still searching for the right mix of branding, distribution, and pricing. It could take several more quarters before the Gap brand returns to prominence, if at all.
Gap has one of the largest apparel e-commerce sites in North America. Online revenue increased 54% Y/Y, as the company continued to prove it could compete online:
We’re pleased to have new leadership at Banana Republic. Sandra Stangl and her team will be focused on repositioning Banana Republic for a post-COVID world with relevant marketing and product. We are becoming digitally dominant. Our online business grew 54% in 2020 and closed the year at about 45% of total company sales up from 25% at the end of last year. At over $6 billion, our online channel is ranked number two in U.S. apparel e-commerce sales and when leveraged with our well located fleet is a strategic advantage in serving our customers through the omnichannel lens.
Retailers have been forced to rely on the digital operations amid the pandemic, and Gap passed with flying colors. Online sales helped offset the diminution of sales through physical locations. It may have set the stage for Gap to be a digital powerhouse after the pandemic ends.
I assumed the decline in scale would hurt margins during the quarter. Actually, margins improved. Gross margin was 37.7%, up 190 basis points versus the year-earlier period. Gross profit on a dollar basis was $1.7 billion, flat Y/Y. Gap saved on rent and occupancy costs as management continued to cull unprofitable stores; the company has been reducing store expenses by closing certain locations for several quarters. The company also negotiated rent abatement, slightly offset by higher shipping costs associated with online sales.
Operating expenses were $1.5 billion, down 20% Y/Y. Operating costs as a percentage of sales was 34.7%, down 640 basis points versus the year-earlier period. Last year the company had about $500 million of one-time SG&A costs related to impairments at Gap's flagship locations, and separation costs at Old Navy.
The fallout was that EBITDA of $260 million improved markedly compared to the EBITDA loss the company reported in the year earlier period. The 5.9% EBITDA margin provides a solid base for Gap to grow from in 2021. Positive EBITDA may have been considered a win, given the lingering effects of COVID-19.
Inventory Remains Bloated
It is important for retailers to maintain ample liquidity to support themselves in case the pandemic or recessionary pressures last longer than expected. Gap ended the quarter with about $2.4 billion in cash and short-term investments. Working capital was $2.1 billion, up from $1.3 billion in the year-earlier period. Merchandise inventory was $2.5 billion, up from $2.2 billion in the year-earlier period. As the business retrenches, Gap should be able to sell down inventory to drive cash flow. Rising inventory amid declining revenue imply the company could have a difficult time moving product.
Gap's debt load was $2.2 billion, up from $1.2 billion in the year earlier period. The company may have needed to raise debt in order to shore up liquidity due to cash burn amid the pandemic. Free cash flow ("FCF") over the past year was -$155 million, down from $709 million in the year earlier period. The company's rising inventory has been a drag on cash flow. Gap's $2.2 billion debt load equates to just over 2x run-rate EBITDA (last three months annualized), so it should be manageable in the near term.
Gap's revenue and EBITDA could improve once the economy fully reopens. This should help management sell down inventory, improve cash flow and improve liquidity. Apparel retailers like Gap, Macy's (M) and Nordstrom (JWN) may not show much traction until the economy fully reopens. Now that Pfizer (PFE), Moderna (MRNA) and others have received Emergency Use Authorization for a COVID-19 vaccine, a pathway to reopening the economy now exists.
GPS has more than doubled over the past year. Its prospects should improve as the economy slowly reopens. I rate GPS a hold.
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