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Gap (GPS) Research Report: Q1 CY2024 Update


Full Report / May 30, 2024

Clothing and accessories retailer The Gap (NYSE:GPS) beat analysts' expectations in Q1 CY2024, with revenue up 3.4% year on year to $3.39 billion. It made a GAAP profit of $0.41 per share, improving from its loss of $0.05 per share in the same quarter last year.

Gap (GPS) Q1 CY2024 Highlights:

  • Revenue: $3.39 billion vs analyst estimates of $3.29 billion (3.1% beat)
  • Gross Margin (GAAP): 41.2%, up from 37.2% in the same quarter last year
  • Free Cash Flow was -$63 million compared to -$102 million in the same quarter last year
  • Locations: 3,571 at quarter end, up from 3,453 in the same quarter last year
  • Same-Store Sales rose 3% year on year
  • (-3% in the same quarter last year)
  • Market Capitalization: $8.09 billion

Operating under The Gap, Old Navy, Banana Republic, and Athleta brands, The Gap (NYSE:GPS) is an apparel and accessories retailer that sells its own brand of casual clothing to men, women, and children.

The core customer is therefore broad, and the aesthetic is a mix of timeless and trendy Americana. For example, The Gap will has always been a good place to find a classic pair of khakis for work. It can also be a destination for a jacket that is a bit more trendy and fashion forward. Prices tend to be towards the affordable end of the spectrum, with frequent sales further enticing customers.

Old Navy features the lowest prices and is the most casual in style. Banana Republic is the most upscale and this is reflected in its prices. The Gap brand sits in the middle with regards to price and style. Athleta, acquired in 2008, offers women’s athleisure clothing such as yoga pants and sports bras.

The Gap’s stores, regardless of brand, are roughly 5,000 square feet and located in malls or shopping centers. They are organized in a similar manner to other clothing retailers, with sections for men, women, and children as well as centralized displays for promoted or seasonal items. The Gap has an ecommerce presence for each of its brands that gives customers various shopping options.

Apparel Retailer

Apparel sales are not driven so much by personal needs but by seasons, trends, and innovation, and over the last few decades, the category has shifted meaningfully online. Retailers that once only had brick-and-mortar stores are responding with omnichannel presences. The online shopping experience continues to improve and retail foot traffic in places like shopping malls continues to stall, so the evolution of clothing sellers marches on.

Retailers offering casual yet trendy apparel for men, women, and children include H&M (OM:HMB), Inditex (BME:ITX) which owns Zara, Abercrombie & Fitch (NYSE:ANF), and American Eagle Outfitters (NYSE:AEO).

Sales Growth

Gap is larger than most consumer retail companies and benefits from economies of scale, giving it an edge over its competitors.

As you can see below, the company's revenue has declined over the last four years, dropping 1.9% annually as it failed to grow its store footprint meaningfully and observed lower sales at existing, established stores.

Gap Total Revenue

This quarter, Gap reported decent year-on-year revenue growth of 3.4%, and its $3.39 billion in revenue topped Wall Street's estimates by 3.1%. Looking ahead, Wall Street expects revenue to remain flat over the next 12 months, a deceleration from this quarter.

Same-Store Sales

Gap's demand has been shrinking over the last eight quarters, and on average, its same-store sales have declined by 2.8% year on year. This performance is quite concerning and the company should reconsider its strategy before investing its precious capital into new store buildouts.

Gap Year On Year Same Store Sales Growth

In the latest quarter, Gap's same-store sales rose 3% year on year. This growth was a well-appreciated turnaround from the 3% year-on-year decline it posted 12 months ago, showing the business is regaining momentum.

Number of Stores

When a retailer like Gap keeps its store footprint steady, it usually means that demand is stable and it's focused on improving operational efficiency to increase profitability. Gap's store count increased by 118 locations, or 3.4%, over the last 12 months to 3,571 total retail locations in the most recently reported quarter.

Gap Operating Retail Locations

Taking a step back, the company has only opened a few new stores over the last eight quarters, averaging 1.3% annual growth in new locations. Although it's expanded its presence, this sluggish store growth lags other retailers. A flat store base means that revenue growth must come from increased e-commerce sales or higher foot traffic and sales per customer at existing stores.

Gross Margin & Pricing Power

Gross profit margins tell us how much money a retailer gets to keep after paying for the goods it sells.

Gap has great unit economics for a retailer, giving it ample room to invest in areas such as marketing and talent to grow its brand. As you can see below, it's averaged an impressive 45.9% gross margin over the last eight quarters. This means the company makes $0.46 for every $1 in revenue before accounting for its operating expenses.

Gap Gross Margin (GAAP)

Gap produced a 41.2% gross profit margin in Q1, marking a 4.1 percentage point increase from 37.2% in the same quarter last year. This margin expansion is a good sign in the near term. It shows the company increased its pricing power, and if this trend continues, it could signal a less competitive environment where it has more negotiating leverage and stable input costs (such as distribution expenses to move goods).

Operating Margin

Operating margin is a key profitability metric for retailers because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.

In Q1, Gap generated an operating profit margin of 6.1%, up 6.4 percentage points year on year. This increase was encouraging, and we can infer Gap was more disciplined with its expenses or gained leverage on fixed costs because its operating margin expanded more than its gross margin.

Gap Operating Margin (GAAP)

Zooming out, Gap was profitable over the last two years but held back by its large expense base. Its average operating margin of 2.9% has been paltry for a consumer retail business. However, Gap's margin has improved, on average, by 4.4 percentage points year on year, an encouraging sign for shareholders. The tide could be turning.

EPS

We track the long-term growth in earnings per share (EPS) for the same reason as long-term revenue growth. Compared to revenue, however, EPS highlights whether a company's growth was profitable.

Sadly for Gap, its EPS declined more than its revenue over the last five years, dropping by 8.3% annually. This tells us the company struggled because its fixed cost base made it difficult to adjust to its shrinking demand.

Gap EPS (GAAP)

We can delve even further into Gap's earnings performance. While we mentioned earlier that Gap's operating margin improved this quarter, a five-year view shows its margin has declined 2.5 percentage points. This was the most relevant factor (aside from revenue) behind its lower earnings; taxes and interest expenses can also affect EPS but don't tell us as much about a company's fundamentals.

In Q1, Gap reported EPS at $0.41, up from negative $0.05 in the same quarter last year. This print easily cleared analysts' estimates, and shareholders should be content with the results. We also like to analyze expected EPS growth based on Wall Street analysts' consensus projections, but there is insufficient data.

Cash Is King

If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe in the end, cash is king, and you can't use accounting profits to pay the bills.

Gap burned through $63 million of cash in Q1, representing a negative 1.9% free cash flow margin. The company increased its cash burn by 38.2% year on year.

Gap Free Cash Flow Margin

Over the last eight quarters, Gap has shown solid cash profitability, giving it the flexibility to reinvest or return capital to investors. The company's free cash flow margin has averaged 5.1%, well above the broader consumer retail sector. Furthermore, its margin has averaged year-on-year increases of 5 percentage points. This likely pleases the company's investors.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was its growth capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money it has raised (debt and equity).

Gap's five-year average ROIC was 3.3%, somewhat low compared to the best consumer retail companies that consistently pump out 25%+. Its returns suggest it was mediocre at investing in profitable business initiatives.

The trend in its ROIC, however, is often what surprises the market and moves the stock price. Over the last few years, Gap's ROIC averaged 4.6 percentage point increases each year. This is a good sign, and we hope the company can continue improving.

Balance Sheet Risk

As long-term investors, the risk we care most about is the permanent loss of capital. This can happen when a company goes bankrupt or raises money from a disadvantaged position and is separate from short-term stock price volatility, which we are much less bothered by.

Gap reported $1.73 billion of cash and $5.5 billion of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company's debt level isn't too high and 2) that its interest payments are not excessively burdening the business.

With $1.30 billion of EBITDA over the last 12 months, we view Gap's 2.9x net-debt-to-EBITDA ratio as safe. We also see its $3 million of annual interest expenses as appropriate. The company's profits give it plenty of breathing room, allowing it to continue investing in new initiatives.

Key Takeaways from Gap's Q1 Results

We were impressed by how significantly Gap blew past analysts' EPS expectations this quarter. We were also excited its gross margin outperformed Wall Street's estimates. The highlight of the quarter, however, was its full-year operating income guidance, which was lifted to mid-40% year-on-year growth from its previous outlook of low-to-mid teens growth. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The stock is up 22% after reporting and currently trades at $27.35 per share.

Is Now The Time?

Gap may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for all companies serving consumers, but in the case of Gap, we'll be cheering from the sidelines. Its revenue has declined over the last five years, but at least growth is expected to increase in the short term. And while its gross margins are a strong starting point for the overall profitability of the business, the downside is its relatively low ROIC suggests it has historically struggled to find profitable business opportunities. On top of that, its shrinking same-store sales suggests it'll need to change its strategy to succeed.

Gap's price-to-earnings ratio based on the next 12 months is 15.5x. While there are some things to like about Gap and its valuation is reasonable, we think there are better opportunities elsewhere in the market right now.

Wall Street analysts covering the company had a one-year price target of $22.14 per share right before these results (compared to the current share price of $27.35).

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