Gap Inc. just made some tough decisions and they’re going over well.
On Thursday, the struggling $16 billion retailer scrapped its plan to spin off Old Navy, said it reorganized top management, and that Gap division head Neil Fiske was let go. The company also expressed confidence in its guidance to Wall Street.
But core issues remain. It’s been years and years of disappointment at the Gap division, which has lost its way and a lot of market share to competitors. It’s revolving door of management hasn’t helped.
Old Navy, while long the cash cow for the corporation, has experienced a recent run of fashion misses and seems to have lost some of the quirky marketing panache that once captivated consumers.
Gap and Old Navy haven’t been immune to the drought in most fashion categories plaguing specialty and department stores, as consumers shift their disposable spending dollars to other areas such as wellness, food and beverage, and travel, and as most retail and wholesale brands demonstrate little newness and innovation.
Meanwhile, Gap Inc. continues to search for a new chief executive officer in the wake of the departure of Art Peck last November. The last three ceo’s — Peck, Glenn Murphy and Paul Pressler — were not fashion merchants. But the company should be considering one for a turnaround.
The news of canceling the Old Navy spin-off pushed Gap Inc. stock up Thursday, though it was mostly flat on Friday,
“It’s the right move not to split the company. It was ill-conceived,” said Walter Loeb, the retail analyst and consultant. “They’d miss the synergies of staying together. Old Navy does have a loyal following and a history of great merchandise, but there haven’t been any really new styles.”
Old Navy has long capitalized on offering strong values in family apparel and such trends as skinny-leg jeans and quilted parkas.
Loeb and other retail experts noted the complexities, costs and hard work involved in spinning off a division. “The challenge is you have to find and put in place a lot of new management,” said one former retail ceo, citing the need to create legal, warehousing, fulfillment, accounting, systems, tech and other functions. Those functions would be shared by Gap and Old Navy and other divisions of Gap Inc. “It’s a lot of work to spin off of a division. It’s very hard to do.”
According to a Cowen report, “Previously, the company estimated dis-synergies of $90 million to $110 million at Gap, and $70 million to $90 million at Old Navy and a one time cost of $400 million to $450 million related to technology platforms, consulting and advisory fees, severance, logistics and other costs.”
In some spin-offs, the new company would utilize some of the functions of the old company, for a fee, though there would be a concern about getting equal levels of service.
“The decision to stop pursuing a company split is now the right one, given Old Navy’s more volatile recent fundamental profile, costs of a split, and the impact on employee morale, in our view,” Randal Konik, analyst at Jefferies, wrote in a research report.
“Damage has been done and will take time to heal, but guidance looks better than feared, which is a positive,” Konick added. “Old Navy needs to show us sustained improvement on a sales and margin basis and stem market share losses from companies like Target before we can get more positive again.
“We view the risk/reward for Gap as balanced given the mixed performance across its portfolio of brands, management turnover and credibility issues with leadership given volatile strategic decision-making.
“The company made some tough decisions today, and they were the right ones,” Konick, wrote in a research report issued Friday.
Additionally, while Old Navy became more promotional during the holiday selling season, “the promos came in better than anticipated, which is encouraging,” Konick said. “Old Navy has likely not yet troughed as Target continues to gain share and could hinder Old Navy’s improvement.”
While Gap Inc. has closed hundreds of stores, mostly at Gap brand, Konick suggested that “more drastic closures or alternative distribution models need to be contemplated for the Gap division.”
Confidence in Gap grew further with the company guiding fourth quarter “moderately above” low expectations and improved margins despite hyper promotional activity.
“The most important lesson learned from Gap’s spin and no spin episode is value creation is tougher than many think, and we believe this will be the same case for LB,” Konick added.
Performance across the Gap Inc. portfolio is mixed. Gap, Old Navy and Banana Republic are weak, though analysts see some progress in margins and improving products. Athleta continues strong and continues to roll out stores.
Wedbush Securities analyst Jen Redding reported that Gap will top consensus marks with its gross margin given favorable promotions at Old Navy. She also said it was “positive” that the spin-off was canceled, considering it a distraction.
Wedbush kept its neutral rating on Gap and price target of $20, while Bank of America Merrill Lynch hiked its price target on Gap to $13 from $11.
Cowen raised its fiscal 2019 earnings per share guidance to “moderately above” the previous range of $1.70 to $1.75 on better margins from lower-than-expected promotional levels, especially at Old Navy, the firm reported.
According to the Cowen report, “It was difficult to justify the separation when Old Navy was comping down low to mid-single digits for the last three-quarters with ongoing merchandise issues in the women’s category, which is becoming more competitive than ever. We believe Old Navy’s lackluster performance has led to share gains by other value players, such as Target…the company has a lot of work ahead to drive consistent performance and rightsize the store footprint. We believe Gap ultimately needs to focus on modernizing the brands to capture younger consumers and master a “test-and-react” merchandise strategy to limit promotions and drive higher unit economics. Moreover, the total company needs to double down on data science, supply chain analytics and customer engagement programs to drive better retention and speed.”
Gap Inc. will report its fourth quarter and 2019 earnings on Feb. 27.
”The work we’ve done to prepare for the spin shone a bright light on operational inefficiencies and areas for improvement,” chairman and acting ceo Robert Fisher said Thursday. “We have learned a lot and intend to operate Gap Inc. in a more rigorous and transformational manner that empowers our growth brands, Old Navy and Athleta, and appropriately focuses on profitability for Banana Republic and Gap brand. Our board is focused on supporting this work and appointing new leadership with the appropriate experience necessary to lead a portfolio of retail brands and to support our transformation efforts.”
With Fiske’s departure from Gap brand, Mark Breitbard, president and ceo of Banana Republic, will now lead Gap, Banana Republic, Athleta, Janie and Jack, Intermix and Hill City. Sonia Syngal, president and ceo of Old Navy, continues in that role.
The decision to not take Old Navy public reflects the woes. Old Navy, Gap and Banana Republic dragged through the third quarter of 2019 when the $16 billion corporation saw its net income fall to $140 million, compared with $266 million a year ago. Comparable sales overall were down 4 percent in the third quarter, with Old Navy Global down 4 percent, Gap Global down 7 percent and Banana Republic Global down 3 percent. Net sales were $4 billion, a decrease of 2 percent compared with last year.
The San Francisco-based retailer now expects total company fiscal 2019 comparable sales and net sales to both be at the higher end of its previous guidance range of down mid-single digits and down low-single digits, respectively. As a result of better-than-anticipated promotional levels over the holiday period, particularly at Old Navy, the company now expects its adjusted fiscal year 2019 EPS to be moderately above its previous guidance of $1.70 to $1.75.