GAP Stock Falls 17% on Mixed Q1 Results, Lower Sales Outlook

Gap Inc. NYSE: GAP delivered a mixed first-quarter report Thursday after the bell, narrowly missing Wall Street’s earnings and revenue expectations for the second straight quarter while lowering its full-year sales outlook due to weaker-than-expected performance at its Old Navy brand.

Although the company, which is in the midst of a multi-year turnaround, raised its full-year earnings guidance, investors appeared more concerned about slowing top-line growth, sending shares down nearly 17% following the report.

Gap’s Q1 Results Show Uneven Product Performance

Gap reported adjusted diluted earnings per share (EPS) of 38 cents, down from 51 cents last year and a cent below Wall Street expectations. Revenue rose to $3.5 billion, up 1% year over year, but fell nearly $28 million short of analyst estimates.

Comparable sales (comps) rose 2%, marking the retailer’s ninth consecutive quarter of positive growth, while gross margin exceeded the company’s guidance by 40.5%.

On the earnings call, CEO Richard Dickson acknowledged that performance was uneven across the company’s portfolio during the quarter.

“Overall, at the company level, the quarter was in line with our expectations. However, the results at the product level were very different, reflecting both different stages of their transformation and other product-specific variables,” said Dickson.

Three of the four Gap brands posted positive year-over-year comps. Gap’s namesake brand remains the top performer, with comps up 10% and extending its streak of positive comps to 10 consecutive quarters. Banana Republic also continued to gain momentum, posting comps growth of 2% and marking its fourth consecutive quarter of positive comps.

Old Navy, the company’s biggest brand, posted comps growth of 1% but fell short of expectations due to weaker-than-expected customer response to its seasonal clothing range. Athleta remains a pain, with comps down 11% as the brand continues to work on key innovations and broader turnaround efforts.

Lower Sales Outlook offsets Higher EPS guidance

Weaker-than-expected performance at Old Navy prompted the company to lower its sales guidance, although it raised its EPS forecast to reflect favorable interest, tax, and share accounting assumptions.

Net sales are now expected to rise 1% to 2% year over year, down from the company’s previous guidance of 2% to 3%. Meanwhile, the company raised its adjusted EPS outlook to $2.30 to $2.40 per share, from its previous estimate of $2.20 to $2.35 per share.

The company also expects about $80 million in tax gains, although it reserves about half to offset the potential impact of higher fuel costs and the remainder to respond to changes in the promotional and competitive environment.

Gap also issued guidance for the second quarter, expecting total sales to decline 1% from last year, and gross margin flat to down 50 basis points.

The Variable Gap Year Continues After the Earnings Report

Investors were clearly disappointed by the report, sending shares sharply lower. The move added to what has already been a difficult year for the stock as investors reacted to developments related to the retailer’s turnaround efforts.

Despite volatile conditions, investors responded well to improving results across Gap’s portfolio early in the year, sending shares to a 52-week high above $29 on Jan. 9. However, the stock fell more than 14% following the company’s fourth-quarter earnings report in early March after the results fell short of expectations.

The stock has struggled to regain momentum since then. Before Thursday’s report, shares were trading just under $25. After the sale, they are now trading below $21. Over the past three months, shares are down about 25%, while the stock is down about 18% year to date.

Analysts Remain Optimistic Despite Pullback

Wall Street remains bullish on Gap, although analyst sentiment has been somewhat mixed in recent months, and at least three analysts have lowered their price targets following the latest earnings report.

The stock carries a consensus rating of Neutral Buy. Among the 18 analysts covering the company, 12 rate the stock a Buy, while six have a Hold rating. The average 12-month price target is just under $29, which represents an upside of more than 35% from recent trading levels.

The recent pullback has also lowered the Gap rating. Shares currently trade at about 10X earnings, below the broader retail industry’s P/E ratio of about 17X. A price-to-sale ratio of less than 0.5 is also well below the industry average of about 1.1.

Operating income of American Eagle Outfitters Inc. NYSE: AEOwhich carries a P/E ratio of about 14X, although it is higher than Abercrombie & Fitch Co. NYSE: ANF more than 7X. On a sales volume basis, Gap trades slightly above American Eagle and modestly below Abercrombie, which recently reported strong Q1 earnings.

Gap’s latest quarter provided evidence that its turnaround is still going well, especially for the namesake Gap brand. However, as it was the second consecutive profit and revenue miss, combined with a lower sales forecast, the positives were overshadowed. Going forward, investors will be looking to see if the challenges at Old Navy are temporary while watching for signs that Athleta’s turnaround efforts are picking up steam.

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