RealMoney Silver - GPS Gaps Up on In-Line Results, Guidance

GPS Gaps Up on In-Line Results, Guidance
By Gary Dvorchak
RealMoney Contributor
2/29/2008 7:54 AM EST

Updated from 3:21 p.m. EST on Feb. 27.

Gap (GPS) is gapping up 6% in after-hours trade on results that were essentially in line with expectations, thus bucking the industry trend of deteriorating fundamentals in a weak retail environment.

The company reported EPS of 35 cents, in line with the Street, on sales of $4.7 billion, also exactly in line. Comps were down 3%, which broke out as Gap brand and Old Navy were both down 5%, while Banana Republic comped up 2%.

Guidance was also essentially in line. Management guided to EPS of $1.20 to $1.27 for the coming year, exactly bracketing the Street's $1.23. The company does expect a point of operating-margin improvement.

Adding to the excitement were two separate press releases that emphasized positive trends in what really matters in a business: cash. The company will commence another $1 billion share repurchase program, and it raised the dividend. Analysts can chatter all they want about various aspects of the business, but cash talks, and management is giving a strong voice of confidence in the company's outlook with the cash usage plan.

The call focused on action items that will impact 2008, notably in the margin focus and real estate strategy. Management is not worrying about comps -- in fact, it stated that comps in 2008 will be "tough" at best and most likely negative throughout the year. Rather, the company is completely focused on maximizing gross-margin dollars. The margin focus results in tactics to improve full-price selling, improve inventory control (expect more declines in 2008), improve labor costs and in real estate rationalization.

The latter consumed a fair amount of management time on the call, indicating its high priority in 2008. Internally, management is calling the real estate plan "the three R's": rightsize, relocate/reposition, remodel. They are concluding that a "sizable amount of the fleet" of stores are not efficiently sized, and will be shrunk as leases come up for renewal or as deals can be negotiated with landlords. The tactic also results in a high yet decelerating number of store closures, with few new stores opening in 2008. Gap brand will take the brunt of the closures, and overall square footage should grow less than 0.5% in the coming year.

The goal is a better inventory and sales per square foot, a laudable goal no doubt.

Management also touched on changes at the key Old Navy division. The CEO noted that he and the old head of the division disagreed on execution and philosophical issues, so a parting of the ways was inevitable. New managers are implementing strong plans, however, such as the faster pipeline initiative or more integrated marketing efforts. He noted that Old Navy needs to better target customers within the three components of the brand (fashion, value and family) and to balance these components better. In the past, one or two have dominated the merchandising and advertising efforts. Old Navy remodels are on hold as the company develops a new store format, so look for a huge remodel program to kick in later this year or in 2009.

The in-line results in a trying environment indicate that new management is starting to do something right at Gap. Furthermore, the cash initiatives are talking loudest, and investors are willing to give the company some leeway to prove it can finally turn. This stock can really work in 2008 if management can hit its margin and efficiency goals, setting it up for traffic improvements and positive comping in 2009.

GPS Preview: Clock Is Ticking

New management came to the Gap (GPS) last year, and naturally, investors are giving them some time to prove themselves. The clock is ticking, however, and when GPS reports on Thursday afternoon, the management team will be one step closer to the do-or-die day, when they need to start showing that the turn is taking hold.

The Street is looking for EPS of 34 cents (GAAP) on $4.7 billion in revenue. Analysts are confident in this outlook, since the company already preannounced the numbers in late January, guiding up to 33 cents to 35 cents from the Street's 28 cents at the time. More importantly, analysts are optimistic about the outlook due to the relatively good comps the company reported recently. The numbers weren't spectacular, but compared to the crappy retail sector overall they weren't too bad.

The company also fired the head of the Old Navy division after 16 months in the position. Clearly, this means that Old Navy isn't turning yet, but at least it will give a glimmer of hope that growth can be reignited there. Old Navy's sluggish performance may depress corporate margins, since the store will be liquidating inventory for the next few weeks.

Gap entered January (the last month of the quarter) with more inventory than planned, and so it was more aggressive than usual in clearing the shelves. Analysts channel checks indicate that the company was successful and should be in a good inventory position at the earnings report.

Gap brand traffic has been slow (-11% in January), although markdowns were minimized and the comp wasn't this bad. Banana Republic executed a strong clearance event, comping 5% for the month.

Of course, all this is ancient history. On the call, investors will probe management on the current state of the consumer, traffic patterns at the malls, inventory levels going forward (i.e., the need for markdowns) and status on the various initiatives to turn the performance at each brand.

The call starts at 5:00 p.m. EST.