will be looking for the retailer's comments on the future rather than the past when it reports first-quarter earnings Thursday after the bell.
"The reality for Gap is that the company can no longer rest on its 'turnaround theme' because the market already 'gets it,'" said Emme Kozloff, a senior analyst who covers Gap for Bernstein. She cited the company's 18 months of positive same-store sales (compared with mostly negative monthly results in 2000 and 2001) and management's prediction that operating margins should be up in the midteens over the next two years.
Consequently, Kozloff is hoping that Gap dishes out a significant growth plan on Thursday. That could help boost the company's stock price, she said, which is roughly flat year to date and up 37% year over year.
Investors are already unsure of their retail holdings in an environment where interest rates are poised to rise, said Kozloff, so Gap needs to give them a reason to hang on. "Vague references to filling out the 'white space' among different consumer segments and some more room for unit expansion in certain divisions does not tally up to enough concrete data points for investors on the sidelines to jump in," she said.
Analysts also want to know what the company plans to do with its sizeable cash on hand. The company ended fiscal-year 2003 with about $4.7 billion in cash and cash equivalents, but meagerly articulated its 2004 outlook. It had said on Feb. 26 that expenses in 2004 should increase 5% to 6% in part due to "strategic growth initiatives," though its total square footage is seen unchanged in 2004 from 2003 levels.
In all, Kozloff doesn't see any growth strategy that would consume all of the company's available cash. As a result, she thinks Gap should not only pay down debt but return capital to shareholders. Both Kozloff and Richard Hastings, retail sector analyst at Bernard Sands, don't see any of that cash going toward acquisitions, due to a lack of obvious candidates.
Gap had about $2.6 billion in total current liabilities at year-end 2003. Kozloff estimates that paying back a portion of debt this year would have a minimal impact on earnings per share. (Directors and employees at Bernstein may hold shares of Gap.)
In addition, the company could use its cash to buy back shares, which would help boost earnings. A $1 billion share repurchase would add about 5 cents to 6 cents a share to earnings in 2004 and 2005, Kozloff estimates. Gap has about 900 million shares outstanding.
The last option is that the company could reward shareholders with a higher dividend, said Hastings. "The one problem that many retailer stocks face is underperformance on the dividend side. They behave like cyclical discretionary companies because that's what they are to the consumer, and then they wind up behaving that way to their shareholders," he said.
Gap pays a regular quarterly dividend of 2.2 cents a share on June 7; raising that quarterly amount would not be a stretch. The company's current dividend yield is 0.4% and Kozloff thinks a 2% yield would be reasonable.
"They're going to be around for a long time, and having a higher dividend rate per share is a way of expressing that," Hastings said. (Hastings does not own shares of Gap and Bernard Sands does not have an investment banking relationship with the company.)
Shares of Gap were up slightly ahead of its earnings release, lately rising a penny at $22.41.
According to Thomson First Call's survey of 26 analysts, each analyst expects Gap to earn 32 cents a share in the quarter, which would be up from 22 cents a share earned in the 2003 period. However, an upside surprise wouldn't be a shocker, as results surpassed consensus by a penny in three of the four quarters in 2003.
The company itself predicted first-quarter earnings of 31 cents to 32 cents a share on May 6, citing "healthy" gross margins. Gap's estimate includes a charge of 2 cents for early extinguishment of debt. At that time, the company also said total sales rose 9% to $3.7 billion while same-store sales increased 7% in the quarter.
For his part, Hastings expects the company to beat the consensus, citing stable and higher prices and improvements in supply chain efficiency.
In terms of future profit growth, Gap's Banana Republic unit could be the division with the most potential, Hastings said. In the last three years, the division has transformed itself into an upscale, higher-priced apparel retailer -- one that Hastings thinks is unique in terms of styles and fabrics.
As a result, gross margins are very high at Banana Republic and it has had stronger operating income growth than the company as a whole, Hastings said.
Further, same-store sales at Banana Republic jumped 21% in the first quarter, Gap said, compared with a 1% increase in the same quarter last year. In contrast, same-store sales at the company's Old Navy division were up 9% in the quarter, and in the U.S. Gap division, same-store sales rose 5%.