The Gap, Inc. GPS has been gaining from lower airfreight, improved promotions and cost-cutting actions. It is on track with the execution of its Power Plan 2023 plan.
Analysts also seem optimistic about the stock. The Zacks Consensus Estimate for GPS’s fiscal 2023 earnings inched up a penny in the past seven days. It has a decent history of delivering earnings surprises, with an average beat of 1,001.6% in the trailing four quarters.
Consequently, shares of this Zacks Rank #3 (Hold) company have risen 16.8% in the past three months compared with the industry’s growth of 3.5%.
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Let’s delve deeper.
Growth Factors Aiding GPS
Gap has been on track with its aggressively undertaking cost-management actions in the second quarter of fiscal 2023. The company has been making efforts to simplify and optimize its operating model and structure. These include increasing spans of control and decreasing management layers to improve the quality and speed of decision-making, as well as creating a consistent organizational structure across all four brands. These actions are expected to generate $300 million in annualized savings, of which half is expected to be realized in the latter half of fiscal 2023.
Apart from these efforts, the company is expected to realize $250 million in annualized savings, as announced in the third quarter of fiscal 2022. Gap revealed plans to further optimize its marketing spend and rationalize its technology investments over the next few years.
The company is on track with the execution of its Power Plan 2023, which focuses on opening highly-profitable Old Navy and Athleta stores, while closing the underperforming Gap and Banana Republic stores. As part of the plan, it expects the Old Navy and Athleta brands to contribute about 70% of sales by 2023.
As part of its 350-store closure plan, the company expects to close 50-55 Gap and Banana Republic stores this year. Gap is likely to fulfill its 350-store closure plan by the end of 2023. It has already achieved 90% of the target in 2022. With the closing of underperforming Gap and Banana Republic stores, the company expects to realize $100 million in EBITDA savings on an annualized basis by the end of 2023.
Further, GPS expects to leverage its powerful platform to deliver competitive omni capabilities to meet customers’ needs, all fueled by its scaled operations. The company targets the e-commerce business to contribute 50% to sales by the end of 2023. Through the plan, it expects to deliver consistent sales growth, margin expansion and a strong operating cash flow.
Also, expansion in merchandise margins stemming from lower airfreight contributed to margins in second-quarter fiscal 2023. Gap’s gross margin of 37.6% expanded 310 basis points (bps) and 160 bps, respectively, from the prior-year period’s reported and adjusted gross margins. Adjusted operating income was $119 million compared with $65 million in the prior-year quarter. Meanwhile, the adjusted operating margin expanded 170 bps to 3.4%, driven by an improved gross margin and adjusted SG&A leverage.
Also, adjusted SG&A expenses declined 8% year over year. Adjusted SG&A, as a percentage of sales, leveraged 10 bps to 36.6% due to lower advertising expenses, payroll and technology investments resulting from cost-saving actions. Owing to these factors, adjusted earnings of 34 cents per share in the fiscal second quarter also significantly improved from the 8 cents reported in the second quarter of fiscal 2022.
Going ahead, management expects continued margin expansion and improved cash flow. The gross margin is likely to expand in fiscal 2023. This is likely to result from a 200-bps leverage due to the lapping of elevated airfreight costs in the prior year and a 100-bps margin gain from improved inventory position and promotional activity, offset by a 10-bps deleverage from inflationary costs.
Additionally, the company expects inflationary deleverage to turn into leverage in the second half of fiscal 2023 due to gains from improved commodity costs and ocean freight rates. ROD, as a percentage of sales, is expected to deleverage 70 bps year over year. For third-quarter fiscal 2023, Gap anticipates the gross margin to be in line with the 38.7% reported last year. It envisions lower inflation and airfreight costs to be offset by 150 bps of ROD deleverage.
Hurdles on the Path
However, Gap has been reeling under uncertain macro and consumer environments. This resulted in a dismal top line in the fiscal second quarter. Net sales dipped 8% year over year to $3,548 million and slightly missed the Zacks Consensus Estimate of $3,597 million. This includes a currency headwind of 1 percentage point and adverse impacts of 2 percentage points from the sale of Gap China. Comparable sales (comps) fell 6% in the fiscal second quarter.
Going ahead, management anticipates fiscal 2023 sales to decline in the mid-single digits compared with the low to mid-single-digit decline mentioned earlier. The company reported net sales of $15.6 billion in the year-ago quarter. It expects sales for fiscal 2023 to include an impact of $300 million from the sale of Gap China and a positive effect of $150 million from the 53rd week.
For third-quarter fiscal 2023, Gap expects a sales decline in the low-double digits, whereas it reported $4.04 billion last year. This can be attributed to the sale of Gap China, which is expected to impact net sales by $70 million in the fiscal third quarter.
Although uncertain macro and consumer environments are likely to linger in the near term, solid merchandise margins, cost-saving efforts and reduced air freight expenses are likely to help GPS drive growth ahead. Topping it, a VGM Score of A and a long-term earnings growth rate of 12% raise optimism in the stock.
Some better-ranked stocks are BJ's Restaurants BJRI, Urban Outfitters URBN and Walmart WMT.
BJ's Restaurants, which operates a chain of high-end casual dining restaurants in the United States, currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
The Zacks Consensus Estimate for BJRI’s 2023 sales and EPS indicates 5.6% and 405.9% growth, respectively, from the year-ago period’s reported levels. It has a trailing four-quarter earnings surprise of 121.2%, on average.
Urban Outfitters, which engages in retail and wholesale of general consumer products, currently flaunts a Zacks Rank #1. The expected EPS growth rate for three to five years is 18%.
The Zacks Consensus Estimate for Urban Outfitters’ current fiscal-year earnings suggests growth of 57.1% from the year-ago reported number. URBN has a trailing four-quarter earnings surprise of 12.2%, on average.
Walmart, which operates a chain of hypermarkets, discount department stores and grocery stores, currently carries a Zacks Rank #2 (Buy). The expected EPS growth rate for three-to-five years is 5.5%.
The Zacks Consensus Estimate for Walmart’s current financial-year sales implies an improvement of 4.2% from the year-ago period’s actual. WMT has a trailing four-quarter earnings surprise of 12%, on average.
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