After visiting Gap Inc. stores in several key markets, Wells Fargo Securities LLC analyst Mark Montagna cut his reduced profit estimates on the retailer after concluding that, if August sales flop, profits could plunge and investors could dump shares.
At recent store visits to Gap, Banana Republic and Old Navy, Montagna found "high levels of markdown merchandise," especially at Gap, he said in a research note Friday. As a result, the analyst predicted the company's second-quarter profits likely will be lower than expected.
The retailer could not be reached for comment.
"We believe that management wants to have the best possible back-to-school floor sets ready by mid-July," Montagna said. "In order to do this, the company will have to take much deeper than planned markdowns to clear the merchandise, yielding the cleanest possible floor sets, in our opinion."
If Gap pulls that off, August same-store sales will be strong, the analyst predicted. But if August bombs, Montagna said he believes shares of Gap will suffer "as investors will then likely begin to doubt the potential success of the remaining fall season."
In May, comps at Gap fell 9 percent while Old Navy and Banana Republic dropped 8 percent and 7 percent, respectively.
As a result of this take on b-t-s and fall, Montagna is maintaining a "hold" rating on shares of Gap while cutting his earnings per share growth rate projection to 12 percent from 13 percent. The analyst also sees shares of the retailer as "fully valued," implying little upside momentum in price. On Friday, shares of Gap finished the day down 2 percent to $19.91.
"For investors considering purchasing Gap shares, we recommend deploying this cash to companies that we believe are more likely to outperform expectations in the second and third quarters," he said, naming Charming Shoppes Inc., Dress Barn Inc. and Talbots Inc. as better bets.
Regarding summer markdowns at Gap as a way to maximize b-t-s sales, Montagna said this "would be a wise, but costly strategy."
"We believe that [the third quarter's] denim emphasis will not steal market share and that denim will not make up for what we expect to be continued low demand for what is likely to be a bland product offering," he added.
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