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Gap turnaround faces hurdles
As sales comparisons become tougher, the specialty retailer's rebound could run into a wall.
October 4, 2003: 9:10 AM EDT
By Parija Bhatnagar, CNN/Money Staff Writer

NEW YORK (CNN/Money) - Executives at Gap may be starting to feel a chill in the air -- and it's not just because of the autumn weather.

Wall Street analysts are concerned that with October here, the year-long turnaround at Gap Inc. could be facing its stiffest challenge yet.

It was a year ago, in October 2002, that the clothing chain broke a string of more than two years of monthly sales declines.

"Next month is the first time the company marks the anniversary of positive sales comparisons. From here on, the comparisons get increasingly difficult," said Ken Perkins, research analyst with Thomson Financial.

Last October, sales at Gap Inc. stores (including the Old Navy and Banana Republic chains) open at least a year -- a key retail measure known as same-store sales -- rose 11 percent, followed by another 9 percent gain in November and a 5 percent rise in December.

"Everybody is waiting to see whether they can carry the momentum they've built this year into next year despite the tough holiday period," Perkins added.

Investor anxiety was amplified after the San Francisco-based retailer's August sales fell short of Wall Street forecasts, sending Gap (GPS: Research, Estimates) shares tumbling 11 percent. The company posted sales gain of 4 percent for the month, missing analysts' consensus estimate of a 7 percent gain.

Perkins expects September sales to increase about 4.7 percent, compared with a 2 percent decline last year. He doesn't yet have a forecast for October.

"This is a classic turnaround story where there's good momentum in the early phase and then you get into the one step forward, two steps back kind of a routine," said Adrienne Tennant, analyst with Wedbush Morgan Securities. Tennant recently cut her rating on Gap to "hold" from "buy."

Shares of Gap Inc. are up 15 percent this year and are near their 52-week high of $23.54.

With the stock trading at 18.4 times this year's expected earnings, it offers a small discount to its peer group price-to-earnings ratio of 19, according to First Call.

Said Tennant, "I love all the initiatives the company has undertaken this past year to cut costs, improve efficiencies and manage the supply chain better. But these are long-term in nature and we'll see the effects two years out. I also downgraded the stock on valuation concerns."

Dennis Van Zelfden, analyst with SunTrust Robertson Humphrey, is bearish on the stock and downgraded Gap to "equal weight" from "overweight."

"We cut our rating on the stock when it hit $22-$23 a share because we thought it's fully valued at this price. We're now on the sidelines because of the tougher comparisons," Zelfden said.

He also doesn't believe the stock will soon revisit the $53 all-time high of early 2000 -- when Gap's store openings and the trend toward casual wear at work were at their peak.

"Two things are happening to prevent that. The industry is much more saturated in the specialty apparel space. Also, Gap's unit growth rate has declined significantly over a three-year period from about 20 percent unit growth a year to a negative 2 to 3 percent now," Zelfden said. "The best thing for [CEO] Paul Pressler to do is to continue pursuing the changes he set in motion and wait for the results."

A basic problem

Under Pressler, the former chairman of Walt Disney's (DIS: Research, Estimates) theme parks and resorts business who took over the reins at Gap in 2002, the company has been working hard to mend its image with customers.

"The mistake Gap made was that it decided to move away from its core customer and become more about fashion by offering younger and trendier looks," said Tom Julian, a fashion trend analyst with marketing firm Fallon.

A big piece of the turnaround was a "get back to basics" effort, offering jeans, khakis, corduroy pants and cotton shirts in basic styles at attractive prices.

So far, at least, results have been good.

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The retailer has posted 11 straight months of same-store sales gains. In its just-completed fiscal second quarter, same-store sales grew 10 percent, compared with a 7 percent decline a year earlier, while net profit in the quarter tripled to more than $200 million from $57 million a year ago.

Gap also showed a substantial reduction in markdowns -- or price-cutting -- as a percentage of sales.

"We've had four consecutive quarters of profit growth, we've paid down a portion of our debt and we're putting the business back on a solid financial and operating foundation," Gap spokeswoman Claudia Hawkins said.

But industry watchers now want to know what's next.

"Gap's put a lot of muscle behind its jeans and corduroy promotions this year and the hype worked in generating a buzz with customers. But neither the jeans nor the corduroys became a category killer for the rest of the industry," Wedbush Morgan's Tennant said.

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"Our research shows that both products aren't knocking anyone off their seats. Gap really needs another big hit similar to the 'Crazy Stripes' campaign last fall of striped hats, scarves and sweaters," she added.

Gap's 2003 holiday campaign is expected to hit the market later this month, said Hawkins, adding the company is "very excited" about its holiday merchandise.

Donald Trott, analyst with Jefferies & Co., said that besides the need for a "must-have" product he wants to see the company boost store traffic in all three of its divisions.

During August, store traffic at Banana Republic declined 6 percent year-to-year, Trott said, while the domestic Gap's divisions dropped 4 percent and Old Navy improved 2 percent.

"Given the uninspiring traffic patterns that have permeated the overall Gap Inc. enterprise for years, the challenge of rebuilding it remains front and center," Trott said.

Trott has a "hold" rating on Gap.  Top of page


--analysts quoted in the story do not own shares of Gap Inc. and their firm does not have an investment banking relationship with the company.




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.