For the first time in more than two years, the company posted two straight years of positive same-store sales growth in a particular month. The company also raised its earnings guidance, saying that when it reports Nov. 20 it expects profits from the just-completed third quarter to come in at least 3 cents higher than Wall Street's estimates.
But the company did little to answer longer-term questions about its direction. Although positive, the company's sales growth in October was slow, and its same-store sales, which compare results at like outlets open for more than one year, are still below the levels the company set three years ago. Meanwhile, the company's year-over-year sales comparisons will continue to be difficult in coming months.
"They're not out of the woods yet, but this is definitely a positive showing for them," said Heather Brilliant, an analyst who covers Gap for Morningstar. (Morningstar does not do investment banking, and Brilliant does not own Gap shares.)
Investors apparently keyed into the positive aspects of the report, sending Gap shares up $1.33, or 7.1%, to $20.04 in recent trading.
After watching its earnings droop and after posting more than two straight years of declining same-store sales, Gap began turning around its operations last year. The company replaced Chief Executive Mickey Drexler and, subsequently, much of its management team. The company developed a new marketing strategy and began closing some of its thousands of stores.
The efforts have been paying off. The company ended its sales decline in September of last year and has since posted 13 straight months of positive same-store sales growth, including a 1% gain last month. During the first half of this fiscal year, the company's per-share earnings have quadrupled from 11 cents a share in the first half of last year to 44 cents a share.
In its monthly sales report on Thursday, Gap said that its earnings improvement continued in its third quarter. The company now expects to post earnings of 26 cents to 28 cents a share in the third quarter. That compares favorably to the 15 cents a share Gap earned in the third quarter last year and to the 23 cents a share in earnings projected by analysts surveyed by Thomson First Call.
Perhaps more impressive, the company's operating income as a portion of sales has jumped from 3.4% in the first half of last year to 9.3% in the first half of this year. The company will likely post earnings before interest and taxes of greater than 11% of sales for the full year this year, compared to less than 4% for all of last year, said Rob Wilson, who covers Gap for Tiburon Research Group. Wilson thinks the company can hit 12% in EBIT next year.
"That's pretty much in line with specialty apparel
companies as a whole," said Wilson, who does not hold Gap shares and whose company does not do investment banking. "Looking at it from that perspective, things aren't all that bad."
But not everything is going great at Gap. Not only were October's sales fairly slow, two of the company's more important divisions posted unimpressive sales. Same-store sales at Gap's core eponymous chain grew by just 1% after growing at the same pace last year. Meanwhile, sales at Old Navy, the company's discount clothing chain, fell 4% after growing at a torrid 24% clip last year.
And sales growth is still negative over the last three years, notes Wilson. Although same-store sales grew 11% in October 2002, they fell 17% in October 2001.
The problem for the company is that it still has too many stores. Gap has begun to close some of its outlets, shuttering about 2% of its store concepts over the last year. But it still has too many underperforming locations that are bringing down its sales performance, said Wilson.
"They've got to do more work there," he said. "They're going to have to get rid of more stores."
But that may be hard for a company that was known as a fast grower in the go-go 1990s. And it may be hard for investors, who are again paying high premiums for growth stocks, to swallow.
Investors need to realize that Gap is no longer a growth story, said Wilson. And while the company's performance may continue to improve, the company still has a way to go before its turnaround is complete.
For her part, Brilliant said the company's stock price jump on Thursday may be a bit of an "overreaction."
"I'm pretty positive on the outlook for the company for the most part," she said. "But I'm not expecting anything huge out of them."