Gap Sags as Fashion Increasingly Influences American Tastes

In a tough month for retailers, the Gap is reeling as its focus on basics shuts it out of the latest trends.
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Even the

Gap

(GPS) - Get Report

, widely considered the

General Electric

(GE) - Get Report

of retailers for its consistent earnings growth, is finding it's subject to the whims of fashion.

And the styles of the moment -- replete with bright colors, more luxurious fabrics and a dressier feel -- run contrary to the basics Gap does best.

That may make for some unfashionable performance, at least in the short run, analysts say. Gap has seen its stock fall 27% from its recent closing high of 51 5/8 on July 8.

To be sure, retail stocks in general are suffering as investors fret over rising interest rates, which could dampen sales growth. But Gap's decline is greater than that of most other retailers. Since July 8,

Limited

(LTD)

has slipped 7.4%,

Federated Department Stores

(FD)

has fallen 11% and

Abercrombie & Fitch

(ANF) - Get Report

has dropped 22%.

Much of Gap's decline has come in the past week since the company reported that July sales at stores open at least a year grew a scant 2%.

"The stock was priced for perfection," says Brian Kirkpatrick, director of securities research at

Bridges Investment Council

, which owns more than 500,000 Gap shares. "Perfection wasn't attainable, and so the stock is falling."

Investors will get a better sense of where Gap's stock will land when the San Francisco-based company reports earnings Thursday morning for its fiscal second quarter. Analysts surveyed by

First Call

expect Gap to earn 21 cents per share for the period ended July 31.

Gap declined to comment for this story, citing the quiet period preceding its earnings release.

"Gap's had fashion problems in the past, and I wouldn't be surprised if that were playing a role this time around," Kirkpatrick says. "If they do have a problem with fashion and they have extra stuff in inventory, you may see some downward earnings guidance." Given these uncertainties, "we're not doing a whole lot of buying, but are waiting to see where this settles out."

Thanks to Tom Ford,

Gucci's

(GUC)

creative director who placed a modern spin on glamour, Americans seem at least willing to open their wardrobes to new styles.

"The vibe is, 'We're bored with dressing down,'" says David Wolfe, creative director of

Doneger Group

, a consulting firm that declines to say whether it has worked for Gap. What that means for men, he says, is wearing pants that resemble the bottom half of a suit rather than khakis. For women, it means bright colors, skirts and delicate "shrug" sweaters.

Companies that have seen strong same-store sales gains in recent months are playing to a more feminine look, says Kindra Hix, an analyst with

Banc of America Securities

who downgraded Gap to hold from buy in October based on some of these

concerns. (Her firm hasn't done underwriting for Gap.)

"Gap will give up some market share to chains like

Express

," a Limited division. Hix rates the Limited a buy. Her firm has performed underwriting for the company.

Express is showing lush, cashmere-blended sweaters and ball gown-inspired dresses for fall.

"They make a pair of khakis look drab," says Paul Raffin, Express' executive vice president of merchandising. "Like you won't be invited to the dance."

To a certain extent, Gap may have little choice but to sit out this dance. While strong in basics like T-shirts and khakis, the company has typically stumbled when it pushed a more fashionable look. The most recent offense was in 1995 when an army of pastels invaded Gap stores. With customers shell-shocked, sales turned flat and operating margins shrunk.

"The core of Gap's business should be basic," argues Todd Slater, an analyst with

Lazard Freres

who rates Gap a buy. "But on the fringe, they should flow in compelling fashion. They lacked enough of that to excite customers in the recent quarter." (His firm hasn't done underwriting for the company.)

Gap's

Old Navy

chain has hit some of the fashion trends more head-on. While the hallmark Gap and

GapKids

divisions saw same-store sales decline in July, strong results at Old Navy allowed the company to record an overall gain. But even Old Navy's torrid sales growth is expected to slow. "You'll see growth, but at a slower pace," Hix says. "Is that enough to offset a deteriorating position at Gap stores?"

To Gap's credit, the stores are stocking jeans decorated with ribbon and embroidery, an item sweeping into malls this fall on the coattails of designs by Gucci's Ford. And Gap's management team, led by Chief Executive Millard Drexler, has been quick in the past to fix fashion mistakes and dream up the next evolution in basics.

Yet so far, this fall is looking mundane. "Think workwear," touts a Gap promotional piece showcasing the company's seasonal lineup. The item that Gap is choosing to highlight as its Next Big Thing is the vest -- perhaps the antithesis of glamour with its bulky fabric and neutral coloring. Figure-flattering it's not.

"The vest is very unisex," says Candice Corlett, a partner with

WSL Marketing

, which hasn't done consulting recently for Gap. "It's not a feminine look." Gap, she adds, is more at risk by placing so much emphasis on an item like a vest, which is less versatile than khakis. "If the vests don't click, I don't see anything else for them right now."

Featuring a top as the key item for a season has an added disadvantage, since tops typically carry lower average selling prices than pants. Also, a customer that buys one pair of pants often buys two tops at the same time. The reverse doesn't always hold true.

Layer these fashion headaches on top of the potential for interest-rate hikes, and it's no wonder investors are skittish.

"I'm staying away," says Jeff Matthews, a money manager with

Ram Partners

. "Gap's never a cheap stock. When a highflier gets wobbly

same-store sales, it's hard to jump in."