Best trends will subside, worst trends will get better: Analyst on Gap earnings

BMO Managing Director Simeon Siegel joins Yahoo Finance’s On The Move to assess the outlook for retailers amid the coronavirus pandemic.

Video Transcript

JULIE HYMAN: Shares of Gap are down about a half a percent right now, recovering from some earlier steeper losses. The company yesterday after the close reported its sales last quarter fell by 43%. It did say, though, it's reopened a lot of its stores, and it did see an uptick in some of its sales for its online brands. By the way, it's also being sued by its major landlord Simon Property over what Simon Properties says is almost $66 million in unpaid rent. So a lot going on with Gap and with retail.

I want to bring in Simeon Siegel now. He's the BMO Managing Director joining us from Westchester, New York. Simeon, let's talk about the earnings first. We'll get to the lawsuit in just a moment.

So 43% drop. The company has been reopening stores. It also saw some pretty decent upticks in online sales for some of its brands. What do you make of its prospects overall? because Gap has been troubled for a couple of years now.

SIMEON SIEGEL: Yeah, and hi, everyone. Good to see you.

I think that everything you just described we can throw every single retail earnings report that we've gotten the last several weeks and say the same thing. I think that this idea of seeing revenues down 30% to 50%, seeing essentially the rest of your margins implode but starting to see this improvement as stores open has been the tale. That's been the narrative.

The question as to whether that's the right extrapolatable trend will continue, right? And I think that we've talked about this in the past on this program. I believe that nothing can be extrapolated right now, right?

The reality is the Gap stores are not going to be closed forever, and people aren't going to be buying sweatpants forever, right? So the best trends we're seeing now are going to subside, and the worst trends are going to get somewhere better. But at the end of the day as it relates to Gap, I think exactly your point. Gap was challenged before this. Gap is too large. I think they need to figure out what the right size of the business should be.

ADAM SHAPIRO: Simeon, it's Adam. Good to see you. One of the things you could extrapolate is that retailers, whether in trouble or not, are going to use what we are living through as an excuse to say to the landlords and the property owners I want a better rent deal, and if not, I've got the leverage of maybe bankruptcy or other avenues.

SIMEON SIEGEL: So I'm not going to pretend to be a bankruptcy lawyer, but I think it is worth noting that companies-- these retailers and all of them have not been paying rent and have been vocal about it for several months. This is the first time we're really hearing about this very loud as the stores start opening.

I think there's this element where we're all in this game of multivariable chicken, right? And in a normal game of chicken, you and I are on the highway. I need you to swerve, and I don't care where you go.

Right now I've got five cars coming at me, and it's an interdependent ecosystem. I need you to survive this. So I need you to get out of my way, but I need you to be alive, and I think that's what we're seeing. The retailers, their landlords, their suppliers, their customers are all trying to push as far as they can without sending someone over the ledge, and I think that's what's happening now.

I think now you're going to start seeing these landlords feel a little bit more emboldened to say I didn't do it while your stores were closed. Now that you start opening and, by the way, you tell me publicly, to Julie's point, that the stores that are opening are starting to do better, OK, well, now we have to start getting back to reality.

ADAM SHAPIRO: Back to reality, but those landlords aren't going to be able to say, well, I'm going to kick you out and go get the same rent from somebody else. Doing better doesn't mean back to normal.

SIMEON SIEGEL: Correct. And then by the way, swerving out of the way and staying on the highway still means you lost that game of chicken. So I think that-- exactly what you're saying. The retailers, for the first time in a long time, find themselves with some leverage, right? These companies that we were saying were structurally challenged can look down the road and say if people have been knocking brick and mortar, well, then it's the owners of the brick and mortar, not the renters of the brick and mortar, that are in the worst position.

So I think that what we see is probably an evolution-- and this is early-- but probably an evolution to more variable rent, percentage rent, as opposed to just paying you a base rent per square foot, and that helps the retailers as they see sales fluctuate.

But I think absolutely right. I mean, Adam, at the end of the day, the retailers still-- the brands still-- it's not as if they're coming back to 2006 glory. Retail is challenging, COVID or not. COVID didn't make it better for the sales trends. It may have given more leverage on the margin.

DAN HOWLEY: Simeon, I want to ask, how do you get people back into stores? How do you want people to return, right? Because we'd already seen kind of the swing over to online shopping prior to this, though we did see some nice spots at Best Buy and Target. But in general, how do you get people back into stores and feeling comfortable when they go there?

SIMEON SIEGEL: It's the whatever-million-dollar question we want to call it. I mean, we can take a poll internally and say how many people have walked back into a store, into a gym within our program? I bet everyone has done to some capacity, right?

I think what's important, to keep in mind, is at the absolute worst of this, people were still going to grocery stores. So there's an element here where I think if we look-- and the Gap's a really good example. The Gap underperformed the average that I look at. So their sales were worse than the average.

The worst group where the off-pricers and the department stores. At the end of the day, one of those, off-pricers, has no e-com. Department stores has a lot.

So what's the other common denominator? They are a box that gives people options. They help discovery.

I think what we're seeing now is shopping right now has become transactional, right? You need a new comfortable wardrobe, so you buy a Lulu pair of sweatpants. You need a set of weights. You need-- everything you need is because discretionary has become functional. Boxes that sell other people's goods help the discovery element. It's part of the reason Amazon's been doing so well.

So, as you say, why-- how do I get people in stores? Well, if they need to go into stores, they will figure out a way they will be in stores. If they don't, that's the harder question. The harder question is figuring out how do you get people into stores that people are supposed to want to be in as opposed to they need to be in.

JULIE HYMAN: So that brings me to Victoria's Secret, Simeon, which is a topic we have discussed with you many times before. How do you get people in those stores?

The UK unit of the company just filed for protection from creditors. It's not quite bankruptcy, but it's sort of a variant. You've said for a long time we need fewer Victoria's Secrets, but you've also said that the brand is viable in the long term. Are you still in that camp?

SIMEON SIEGEL: Yeah, isn't it crazy that I can look at that announcement and actually think that's a positive? I think that what we need-- and we've spoken about this so frequently. This idea of shrink to grow, I know it just sounds either nice or not, but there are companies-- Victoria's Secret was one of the largest brands in the history of time and it doesn't make money. That doesn't make sense. They sell clothing.

So the reality is I think over the last however many decades public companies were tasked with growing at any expense, and that dilutes the brand, right? That creates the need for discounts. If you have an arm of your business that's simply not making money, COVID, ironically, creates this newfound opportunity. It's literally the first time in history that these companies need to decide how many stores to open, not how many to close. So you get to start from zero and build your way back up.

The international arm of Victoria's Secret-- which, by the way, took them a very long time to agree to do in the first place-- loses $50 million, so the UK and China combined. So if it's not working, move on, and that's such a hard thing to do as a public company except for right now.

So I think that take that-- take that announcement. It gives them more leverage, right, to Adam's earlier point, with landlords and flexibility. Couple that with the announcement that they're going to close 25% of their store fleet to start, and then I would expect the next time we're on this-- I would expect-- you're asking me is it true Victoria's Secret just pulled back all those promotions and are seeing sales plummet and you still like that? And I will say yes because every incremental piece of sale that goes through at a higher margin is going to be great.

JULIE HYMAN: Predicting the future once again. Simeon Siegel of BMO, good to see you. Thanks for your time.

SIMEON SIEGEL: Good to see you guys.