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Gap posts 26 percent rise in earnings

Gap Inc posted a 26 percent rise in quarterly earnings on Wednesday, beating analysts’ estimates by a penny, but a raised forecast for the full year failed to match some Wall Street targets and its shares fell on the news.
/ Source: Reuters

Gap Inc posted a 26 percent rise in quarterly earnings on Wednesday, beating analysts’ estimates by a penny, but a raised forecast for the full year failed to match some Wall Street targets and its shares fell on the news.

Chief Executive Glenn Murphy said the retailer of casual clothing faced a “tough economic environment” for the holiday sales season, which kicks off in earnest this weekend after the U.S. Thanksgiving holiday.

Cost-cutting measures, restructuring and managed inventory helped boost profit at the apparel giant that has been battling slumping sales, but quarterly sales at established stores fell 5 percent in the third quarter.

“They raised their guidance for the year, but their high end is in line with consensus and that’s disappointing because it means there is potential downside,” said Needham & Co analyst Christine Chen.

C.L. King analyst Mark Montagna said Gap considered the holiday promotional environment in its outlook and, to date this year, has erred on the conservative side of forecasts.

“Considering their inventory management skills, they can clearly achieve this guidance,” Montagna said.

The company, which operates over 3,100 stores around the globe, said third-quarter net income rose to $238 million, or 30 cents per share, from $189 million, or 23 cents per share, a year ago. Sales were flat at $3.85 billion.

Analysts, on average, were expecting earnings of 29 cents on sales of $3.83 billion, according to Reuters Estimates.

“We also feel this is going to be a tough economic environment in this holiday selling season. We feel good we’ve been disciplined on the inventory front,” Murphy said on a conference call with analysts.

“The consumer will ultimately be the judge, but we feel we’re well positioned for the holiday season, though we’re clearly aware this is going to be a tougher environment than we faced last year,” he said.

Gap, which named Murphy as its new chief executive in July, has been reducing inventories, trimming costs and cutting jobs as it tries to revamp its product lines at its two main chains, Gap and Old Navy. Earlier this month, the retailer raised its third-quarter earnings outlook to a range between 28 cents to 30 cents per share.

The company, whose holiday print ads at its Gap chain feature colorful, striped scarves and sweaters reminiscent of past popular Gap fashions, pared back marketing spending this quarter, saving some $75 million, by deciding not to run television ads as it had last year.

Black said Gap’s more careful spending choices are smart and contrast with past decisions to push expensive marketing campaigns, even with merchandise not up to par.

“I think they’re being incredibly realistic. I think Glenn is taking a slow methodical approach to this, but timely enough,” Black added.

Regarding Gap’s full-year outlook, Black said investors need to remember the company is still in transition.

“I think they wanted to make it very clear to people not to get the expectations way up there because it’s still in a turnaround,” Black said. “I feel this is a good bet. It will take some time and the company has a good balance sheet.”

Many on Wall Street believe Gap may finally be beginning to emerge from a years-long sales slump due to unfocused merchandise and competition from a host of rivals, but say it will take time for traffic to come back to the once-iconic retailer.

The company increased its full-year net earnings outlook to a range of 92 cents to 98 cents from an earlier view of 83 cents to 88 cents. On an adjusted basis, it expects earnings between 99 cents and $1.05 from an earlier view of 90 cents to 95 cents. Analysts, on average, had been expecting full-year adjusted earnings of $1.05, Chen said.

Gross margins in the quarter rose by 0.1 point from a year earlier, while operating margins rose by 2.2 points.

The shares of San Francisco-based Gap trade at 17 times projected 2008 earnings, above retailer Limited Brands Inc and the Dow Jones Retail Index at 10 and 15 times forward-looking expected earnings, respectively.