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Gap (GPS) is Well-Poised on Growth Initiatives Amid Cost Woes

The Gap, Inc. GPS has been gaining from sturdy demand and strength in the Athleta brand. Its cost-cutting actions bode well. This led to third-quarter fiscal 2022 results, wherein the top and bottom lines surpassed the Zacks Consensus Estimate. Also, both metrics improved year over year.

Results gained from sturdy demand for formal clothing and dresses, as people are preferring more formal clothing, dresses, woven tops and pants, and shelving casual wear as they return to travel, work and social occasions after two years of the pandemic.

Adjusted earnings of 71 cents per share compared favorably with earnings of 27 cents in third-quarter fiscal 2021. Net sales rose 2% year over year to $4,039 million. The metric also grew 1% from the pre-pandemic level. Comparable sales (comps) inched up 1% on a year-over-year basis.

We note that shares of this Zacks Rank #3 (Hold) have risen 53.8% in the past three months compared with the industry’s 5.4% growth.

 

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That said, let’s delve deeper into the factors driving the stock.

A Brief Introspection

Continued momentum across its Athleta brand has been acting as a key growth driver for long. The Athleta brand’s value-driven active and lifestyle categories, increased digital marketing investments, and focus on product strategy have been aiding sales.

In third-quarter fiscal 2022, net sales jumped 6% to $340 million for the Athleta brand, while the metric grew 57% from the pre-pandemic levels. Comps remained flat year over year.

Segmental results gained from positive responses for fall and holiday products, particularly in bottoms and tops. Increased focus on performance active, as well as active lifestyle products to capitalize on the evolving shopping trends, bodes well. It has also emerged as one of the fastest-growing women's athleisure brands in North America. Driven by these factors, Athleta remains on track to reach $2 billion in net sales by fiscal 2023.

The company has been aggressively undertaking cost-management actions in the fiscal third quarter. Some notable efforts are the elimination of 500 existing and open positions in its corporate offices, a hiring freeze, a pause on contractor spend for the rest of the year, the renegotiation of advertising agency contracts, reduced technology and operating costs, and rationalized investments. This resulted in roughly $250 million in estimated annualized savings. Such endeavors are likely to help offset higher incentive compensation and rising labor costs in fiscal 2023.

Gap is on track with the execution of its Power Plan 2023, which focuses on opening highly profitable Old Navy and Athleta stores, while closing the underperforming Gap and Banana Republic stores. As part of the plan, the company expects the Old Navy and Athleta brands to contribute 70% to sales by 2023.

Notably, the company closed 29 Gap and Banana Republic stores in North America in the nine months ending Oct 29, 2022. It expects to close 30 more in the fourth quarter of fiscal 2022. With the closing of underperforming Gap and Banana Republic stores, the company expects to realize $100 million in EBITDA savings on an annualized basis by the end of 2023.

Hurdles on the Way

Gap has been reeling under longer transit times, more delays, pack-and-hold strategies, and elevated levels of slow-turning basics and seasonal products. Management expects inventory to remain high in the fiscal fourth quarter due to remaining fall products despite higher markdowns in the reported quarter.

Huge discounts and elevated commodity prices dented margins in the fiscal third quarter. Notably, the adjusted gross margin contracted 320 basis points (bps) year over year, whereas the adjusted operating margin contracted 40 bps year over year.

Management expects sales to decline year over year in the mid-single digits in the fourth quarter of fiscal 2022. This might result from the continued uncertain consumer environment and higher promotions.

The company raised concerns about a drab holiday season this year. Also, rising prices of essential commodities are likely to continue to hurt lower-income consumers' spending on non-essentials like apparel.

Bottom Line

All said, strength in Gap’s Athleta brand, cost-management efforts and the Power Plan 2023 strategy are likely to help it sustain its momentum despite cost woes. Topping it, a long-term earnings growth rate of 12% raises optimism in the stock.

Stocks to Consider

Here are three better-ranked stocks to consider, namely Wingstop WING, Dollar General DG and Chipotle Mexican Grill CMG.

Wingstop currently sports a Zacks Rank #1 (Strong Buy). WING has a long-term earnings growth rate of 11%. Shares of WING have declined 9.2% in the past year. You can see the complete list of today’s Zacks #1 Rank stocks here.

The Zacks Consensus Estimate for Wingstop’s 2023 sales and EPS suggests growth of 18.1% and 16.4%, respectively, from the year-ago period’s reported levels.

Dollar General, a discount retailer, currently carries a Zacks Rank #2 (Buy). DG has an expected EPS growth rate of 11.1% for three to five years.

The Zacks Consensus Estimate for Dollar General’s current financial-year revenues and EPS suggests growth of 10.8% and 13.8%, respectively, from the year-ago reported figures. DG has a trailing four-quarter earnings surprise of 2.2%, on average.

Chipotle Mexican Grill, an operator of fast-casual restaurants, currently carries a Zacks Rank of 2. CMG’s expected EPS growth rate for three to five years is 23.4%.

The Zacks Consensus Estimate for Chipotle Mexican Grill’s current financial-year revenues and EPS suggests growth of 15.2% and 30.8%, respectively, from the year-ago reported figures. CMG has a trailing four-quarter earnings surprise of 4.1%, on average.

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