Great Atlantic & Pacific Tea (GAP) recently reported earnings, a company we rate a sell. Our recommendation is based on the company's weakness in fresh segment sales, dwindling cash position and reported net loss.

In addition, GAP faces risks from mounting debt, negative returns and a weak liquidity position. However, impressive revenue growth, increasing shareholders' equity and higher average weekly sales per supermarket are the upsides to our sell rating.

Here are the earnings highlights:

  • The company's fresh segment performed poorly. GAP's third-quarter sales at its fresh segment contributed 50.5% of the total sales. Sales in this segment declined 2.9% to $1.07 billion from $1.10 billion, due to store closures.

  • GAP swung to a net loss of $13.63 million, or $1.35 per share, from a net profit of $57.31 million, or $1.73 per share, in the third quarter of 2007. The year-ago results benefitted from a gain of $106.06 million from the sale of Metro Inc. shares. Loss from continuing operations totaled $2.99 million compared to net profit of $73.08 million in the prior year's quarter.

  • GAP reported a dwindling cash position and higher leverage level. The company's cash position during the third quarter dwindled, as reflected by a 72.9% decline in cash and cash equivalents and a quick ratio of 0.47. Moreover, the debt-to-equity ratio deteriorated to 3.29 from 1.49 a year ago, as total debt surged 176.1% to $1.49 billion.

  • Other metrics are also negative. Dragged down by reported net loss, return on equity swung to negative 10.48% from a positive 33.46% in third-quarter 2007. Similarly, return on assets stood at a negative 2.43%, compared to a negative 5.16% a year earlier.

There are risks to our sell rating.

GAP's overall revenue grew 69.5% to $2.12 billion over the previous year's quarter, fueled by the acquisition of Pathmark stores. Additionally, GAP realized synergies of $30 million during the third quarter from the integration of Pathmark. Moreover, GAP expects to start generating positive cash flow in in the fourth quarter and in fiscal year 2009.

Great Atlantic & Pacific Tea's revenue during the third quarter surged 69.5% to $2.12 billion from $1.25 billion in third-quarter 2007, on the back of a 1.9% growth in comparable-store sales and acquisition of Pathmark stores. However, comparable-store sales of Pathmark declined 0.5% year over year.

Product-wise, grocery sales spiked 76.8%, to $1.51 billion, while meat sales soared 60.8%, to $388.58 million. Moreover, produce sales were $226.09 million, up 43.5% over third-quarter 2007. Segment-wise, fresh sales declined 2.9%, to $1.07 billion, due to the absence of sales from store closures.

Price Impact generated revenue of $924.37 million compared to $32.59 million a year earlier. Gourmet sales and other revenue increased 6.6% and 11.4%, to $67.15 million and $58.07 million, respectively. Average weekly sales per supermarket rose 19.8%, to $417,800 from $348,800 a year ago, due to the acquisition of Pathmark's larger supermarkets in the fourth quarter of 2007.

Great Atlantic's gross profit margin during the latest third quarter improved 87 basis points to 33.99% from 33.12% a year ago. This is due to higher revenue having offset a 68% increase in cost of merchandise sold to $1.46 billion from $869.45 million. Store operating, general and administrative expense grew 61.0%, to $648.48 million from $402.81 million.

Conversely, operating margin improved to a positive 0.79% compared to a negative 1.32% in the third quarter of 2007. Interest expense more than doubled to $36.73 million from $14.50 million. Interest coverage ratio turned to a positive 0.45 from a negative 1.14 a year earlier.

Overall, the company swung to a net loss of $13.63 million, or $1.35 per share, compared to a net profit of $57.31 million, or $1.73 per share. The comparable quarter in the last year included a gain of $106.06 million from the sale of Metro Inc. shares. Loss from continuing operations totaled $2.99 million against net profit of $73.08 million in the prior year's quarter.

Cash and cash equivalents at the end of the third quarter dwindled 72.9% to $165.58 million from $611.52 million. Moreover, a quick ratio of 0.47 reflects the company's potential inability to cover any short-term cash needs. Total debt more than doubled to $1.49 billion from $538.29 million.

Shareholders' equity soared 25.4% to $451.91 million from $360.36 million. As a result, the debt-to-equity ratio worsened to 3.29 from 1.49. Meanwhile, return on assets improved to a negative 2.43% from a negative 5.16% in the third quarter 2007, while return on equity deteriorated to a negative 10.48% from a positive 33.46% a year earlier.

During the quarter under review, GAP operated 444 stores compared to 322 stores in the year-ago quarter. The company realized approximately $30 million of synergies from the acquisition during the quarter comprised of reduced administrative, merchandise and store operating, marketing and advertising costs.

Looking forward, GAP continues to expect positive cash flow for the fourth quarter of 2008 and fiscal year 2009. Furthermore, the company plans to spend around $130 million during fiscal year 2009 for capital expenditures.

This article was written by a staff member of TheStreet.com Ratings.

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