ANALYSTS AWAIT GAP COMEBACK

Byline: Janet Ozzard / Thomas J. Ryan / Kristin Young, Los Angeles

NEW YORK — There’s no doubt in analysts’ minds that Gap Inc. will pull it back together. Their question is, when?
After a year of glitches, miscues and switches in the product, marketing and advertising, the $13 billion San Francisco-based giant is still having a tough time at all three divisions: Gap, Banana Republic and Old Navy. Gap Inc. has posted five consecutive months of same-store sales declines, including a hefty 14 percent drop during August, the height of crucial back-to-school sales, and 8 percent in September. The stock closed Thursday at $23.12, down 38 cents on the Big Board, which is a 56.9 percent tumble from its year-high of $53.70 notched on Feb. 4. There have been executive shufflings aplenty; as reported in WWD Thursday, it replaced Gap merchandising veteran Lisa Shultz with Jerome Jessup as executive vice president of product design and development for the brand worldwide. Jessup came from Banana Republic.
“We don’t feel there are any fundamental issues,” chief executive Millard (Mickey) Drexler told a crowd of financial analysts two months ago. “We are moving with great urgency to fix these things for holiday. In all three brands, you’ll see good-looking goods.”
Wall Street’s general consensus is that Gap is facing a combination of situations, both internally and externally, that are working against the retailer.
On the fashion front, analysts say all three divisions of Gap are facing an identity crisis. Old Navy is battling tough competition from other discounters, especially Target and Wal-Mart, two retailers that have copied some key concepts and undercut the chain on price. Gap and Banana Republic, meanwhile, now have to contend with H&M, Zara and Club Monaco.
“It’s a confluence of things,” said Barbara Miller, an analyst at Goldman Sachs & Co. “That makes it a challenging situation for people at the Gap and for us as analysts.”
Donald Trott, at Jeffries & Co., said he believes Gap has “bottomed out” and sales should revive as Drexler, who he nicknamed the “Merchant Maestro,” gets more involved with daily operations. Analysts consider positive, for example, that Drexler now takes part in conference calls instead of leaving that solely to chief financial officer Heidi Kunz.
“I think part of the problem is that the Gap has reached a size where Mickey was trying to delegate a little bit too much,” Trott said. “I think Mickey will orchestrate an improved merchandise effort, both by getting more involved and by shoring up his management team.”
“We believe easier sales comparisons and the opportunity for Old Navy to contribute more meaningfully to sales and earnings momentum could be powerful drivers to an improved valuation,” said Morgan Stanley Dean Witter’s Robert F. Ohmes.
Anne-Marie Lillestrand, a research analyst at Thomas Weisel Partners LLC, said that Old Navy’s price points have been moving up steadily over the years.
“Prices should be consistent with the value and position of the Old Navy concept,” she said.
Beyond being characterized as having too much sameness between divisions, the core Gap stores and the Banana Republic division are involved in a fashion environment that is increasingly fragmented.
“Given that fashion has moved somewhat away from the look that Gap has dominated and done well with in terms of basic American casual with some attitude,” said Miller, “it makes it a little more difficult for Gap to maintain its dominance because the influx of variety in fashion is creating more options for the consumer.”
This is a point not lost on John Morris, an analyst at Gerard Klauer Mattison & Co., who added that Gap should not walk away from denim and basics.
The merchandise has begun to improve, say analysts.
“The early holiday merchandise in all divisions looks much better,” said Dorothy Lackner, at CIBC Oppenheimer. “The Gap chain, which had gone a little bit too youth-oriented, has gotten more balanced in its mix. What’s there is colorful, it seems to be hitting all the fashion marks and it just looks very good.”
Old Navy, which has been plagued by inventory gluts due to distribution problems, “looks much cleaner and the merchandise looks better,” said Lackner. That includes good gift items for the crucial holiday season.
The frosty reception consumers gave Banana Republic’s fall merchandise — dubbed a “purple problem” by analysts because of the heavy concentration of violet items — should warm up with the pinks and mauves offered for early holiday, Lackner said.
This has been Gap’s year for turnover at the top management level. Analysts say they believe some changes may have been appropriate firings, but there’s little doubt that key talent has left the company as well.
More than any other outward sign, Morris said he believes the management shuffle is indicative of the structural difficulties that Gap is facing and a sign that these obstacles could remain for the foreseeable future.
“Key talent is voting with their feet by walking out the door,” he said.
“The greatest amount of defections always occur at the point of most distress,” agreed Todd Slater, an analyst at Lazard Freres & Co. LLC. “Whether or not this signifies a bottoming out or not, I don’t know.”
Slater noted that all three divisions are underperforming and believes one cause is a supply and demand imbalance in the market.
According to an index of 75 specialty stores by Lazard Freres, supply has increased at its fastest rate in the last 10 years. In 1997, there was a supply growth of 1 percent. In 1998 that figure increased 3 percent. In 1999, supply growth jumped 10 percent and an additional 10 percent is expected for 2000, Slater said.
Analysts are also considering the pace at which Gap plans to continue its store expansion. This year, the retailer expected to increase its square footage by about 30 percent. Next year, the goal is 20 percent.
“Accelerating capacity at a time when consumer demand is slowing is a recipe for serious margin and sales erosion,” said Slater.
Overall, analysts say Gap’s expansion plans should be revisited.
Meanwhile, there are the holidays, and based on the merchandise and marketing plans for all three divisions, analysts have their hopes up. These plans include a new ad campaign for Gap done by an outside agency for the first time and new TV and print ads for Old Navy.
“Operationally, they’ve completed the necessary markdowns,” said Richard Jaffe, an analyst with PaineWebber, noting that during much of the second and third quarter, the retailer has been engaged in substantial promotional activity.
Several analysts say they also believe in Gap’s long-term viability.
“Can they figure things out?” asked Miller. “No question. But, there’s also no question that there’s an awareness, if not a laundry list, of solutions. This company is certainly in the trenches trying to figure things out.”
Tony Cherbak, a partner at Deloitte & Touche’s consumer products group in Orange County, Calif., looked at the big picture.
“You can’t measure them over a period of the last four to six quarters,” he said. “You’d be hard pressed to find a company that has long-term sustained impact on consumers, across all segments, as a whole. They are the company that comes to mind when you think of great American retailers.”

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