Last week apparel retailer Gap (NYSE:GPS) had another opportunity to demonstrate that management has found a way to finally boost its sales growth prospects. That opportunity quickly passed, though it continues to perform admirably on the cost front. This strategy is working out well for shareholders in the short term, but won't over the longer haul.
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Quarterly Review
Sales fell 7% to $3.25 billion as growth in online sales was more than offset by a lower store base and negative same store sales. Net square footage fell 0.3% as Gap opened 12 stores but closed 16 locations. Total comparable sales fell 8% on double-digit declines at the namesake North American Banana Republic stores and mid single-digit declines at Old Navy and the International store base. Online sales improved 17%.
In terms of sales breakdown of the three largest segments, Gap North America accounted for 27% of quarterly sales, Banana Republic brought in 16% of sales and Old Navy weighed in at 38% of sales.
Cutting Costs
Given the continued top line challenges, Gap has turned to cost controls to boost profitability. Gross margins improved 150 basis points on lower sales markdowns and operating margins also improved to 11.6% of sales. It also managed to lower inventory by 14%. Yet despite the expense discipline, Gap was not fully able to overcome the drop in sales and saw net income fall a modest $1 million to $228 million. However, share buybacks allowed earnings to grow a penny to 33 cents per diluted share.
Gap's quarterly earnings beat analyst projections. Full-year projections currently stand call for a 5.4% decrease in sales to $13.7 billion and $1.32 per share in earnings, which would represent a slight year over year decline. This is in stark contrast to archrival Aeropostale (NYSE:ARO) as it also reported second-quarter results last week but saw sales grow 20% and profits nearly double.
The Bottom Line
Gap plans to boost advertising at Gap and Old Navy to boost customer traffic and will continue to play around with merchandise mix, new store layouts and product repositioning. For instance, it relaunched its denim line with a higher-priced offering that The Buckle (NYSE:BKE) and True Religion Apparel (Nasdaq:TRLG ) have been making money off of for some time now.
However, until top line trends stabilize, further share price upside appears very limited. The stock has seen a boost from cost cutting and a focus on generating free cash flow, but there is only so much fat that can be trimmed from operations before it starts cutting away muscle. This is something that shareholders at Sears Holdings (Nasdaq:SHLD) can attest to as years of cost cutting may have permanently impaired the competitive position of the flagship Sears and K-Mart store bases.
In other words, unless Gap can grow sales consistently for a number of quarters in a row, the stock looks to be a value trap. (For more, check out Analyzing Retail Stocks.)
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