Analysts Getting Bearish on Gap

Wall Street isn’t so sure about Gap Inc.’s future, hitting the retailer with two stock downgrades in a week.

NEW YORK — Since its streak of 20 months of consecutive same-store sales gains was snapped in May, Gap Inc. has been caught in the backdraft of intensified competition and picky consumers.

And on Wall Street, the specialty retailer can’t seem to catch a break. Piper Jaffray on Wednesday hit Gap Inc. with its second stock downgrade in a week and Lazard Fréres & Co. and Banc of America Securities announced downward profit revisions. Wachovia Securities downgraded Gap Inc. last week.

Retailing in the last several months has struggled with several trends, including shoppers with more discretionary money being lured by branded goods at department stores. There are also economic factors such as higher fuel prices and queasiness over the job market, which have driven some price-sensitive shoppers out of stores. Within the specialty retail channel, consumers seem to be switching allegiances.

For Gap, the consensus among analysts is that the retailer has improved its operations, and that Paul Pressler, president, chief executive officer and director, has led a turnaround of the company. And their longer-term outlook is positive as management seeks to bolster its cash flow and improve operations. Still, the analysts said the market position of Gap, which hired Sarah Jessica Parker for its glitzy new advertising campaign, is threatened by competitive forces as well as a change in how and where consumers choose to spend their discretionary dollars.

Jeffrey Klinefelter, equity analyst at Piper Jaffray, said in his research note that he was downgrading Gap’s stock to “Market Perform” from “Outperform” because “sales trends will continue to moderate in the Gap and Old Navy divisions.” He also lowered his price target on the stock to $21 from $23. Shares of Gap Inc. have been trading around $19, above its 52-week low of $17.80, but well below the 52-week high of $25.72.

Stacey MacLean, spokeswoman for Gap Inc., said the company does not comment on analyst actions or on the value of its stock.

For the third quarter, Klinefelter sees Gap delivering flat comps — sales in stores open at least a year — instead of a previous estimate for a 3 percent gain. He based his downgrade on several factors, including consumer discretionary dollars being drawn to higher-end stores where shoppers are attracted to branded denim.

This story first appeared in the October 7, 2004 issue of WWD.  Subscribe Today.

“We are not predicting any fundamental change in the current trajectory of the company,” Klinefelter said in his report. “Indeed, we believe management has done a remarkable job in turning the company around, particularly realigning each concept with its core customer.”

Still, after two years of strong same-store sales, Gap Inc.’s comps in the trailing 12 months have gone from gains of 12 to 13 percent to declines of 1 to 5 percent. Analysts expect Gap to post lackluster same-store sales in a report today.

But what has analysts in a tizzy is Gap’s premature move in marking down fall items. Last week, the retailer slashed prices on certain goods by 40 percent. This week, the markdowns came in at 50 percent.

As a result, Lazard Fréres equity analyst Todd Slater said in a research note Tuesday that he was “taking a more conservative margin view and lowering [the] outlook for the second half of the year, due to the aggressive nature of the company’s promotional cadence in the last couple of weeks.”

MacLean said Gap has “had sales that were consistent with last year. We have promotions at this point.’’

She said the “up to 40 percent off” sale was launched a few days ahead of schedule. “Within the month we have a certain number of planned promotions, but we have the option to move them around and be flexible,” she said.

Slater cut his third-quarter earnings per share estimate to 27 cents from 29 cents, and the fourth-quarter estimate to 44 cents from 47 cents. For 2004, the analyst expects EPS to come in at $1.24.

Although bad for gross margin rates, sales prices seemed to be a hit with shoppers at the Gap store in Herald Square here that was bustling with a lunch crowd on Wednesday. Selected men’s wear, women’s tops and bottoms, including denim and corduroy, and V-neck and turtleneck sweaters were marked down as much as 50 percent. Banana Republic also promoted selected fall items for 50 percent off. This was in contrast to nearby competitors Forever 21 and H&M, which were selling fall items at full price.

Dana E. Cohen, equity analyst at Banc of America, cut her third-quarter earnings per share estimate by one cent “due to the incremental markdowns taken at the Gap division” over the past week.

“We think the fact that the company has taken incremental markdowns in one week is significant,” Cohen wrote. “Store signage now reads up to 50 percent off versus 40 percent off last week, and we also saw a meaningful amount of double markdowns in clearance, as well as a few in the fall merchandise.”

It may be too early to tell what kind of impact markdowns will have on Gap’s gross margin rate. However, stepping back and looking at long-term operating profit trends, the picture is bright.

Last week, Standard & Poor’s credit analyst Diane Shand praised the retailer’s efforts “to improve product quality and assortment, store execution and inventory management,” which “significantly improved operating performance.”

She noted Gap’s operating margin jumped to 22.7 percent in the trailing 12 months ended July 31, from 21.1 percent in the previous year, “and a low of 14 percent in 2000.” Shand said Gap could make further margin improvements via more full-priced selling along with leveraging costs.

After stabilizing the business and delivering 20 months of positive comps, “progress has recently stalled in terms of sales: Same-store sales have been negative for the past three months,’’ the analyst said. “As the company is not growing its store base, its financial performance is vulnerable to swings in comparable-store sales.”

— With contributions from Meredith Derby

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