TJX TJX Companies Inc

Battered by negative comparable store sales growth, increased input costs and deep discounting, Gap Inc.’s (GPS) fourth-quarter 2011 earnings slide 27% to 44 cents per share from the prior-period earnings of 60 cents per share. However, quarterly earnings managed to beat the Zacks Consensus Estimate of 42 cents per share.

Quarter in Details

During the quarter, net sales edged down 1.9% to $4,283 million from $4,364 million in the year-ago quarter, primarily due to higher discounting offers to lure customers during holiday season and negative comparable store sales growth. However, total revenue of $4283 million nominally beat the Zacks Consensus Estimate of $4,282 million.

Same-store sales slipped 4% for the quarter versus an increase of 1% in the prior-year quarter. The decline is due to a drop in same-store sales across all brands, except a flat year-over-year comparable sales at Banana Republic North America. Same-store sales of Gap North America, Old Navy North America and International brands declined 3%, 6% and 8%, respectively.

Quarterly gross profit fell 15.8% year over year to $1,405 million, primarily due to higher input costs. Consequently, gross margin contracted 540 basis points (bps) to 32.8%.

Gap’s operating income plunged 37.3% year over year to $372 million and operating margin shriveled 490 bps to 8.7%, marginally offset by a benefit of 60 basis points from leveraged operating expenses as a percentage of sales.

Fiscal 2011 highlight

The company’s earnings of $1.56 per share for fiscal 2011 declined 17% from the previous fiscal earnings of $1.88. However, it managed to surpass the Zacks Consensus Estimate of $1.54 per share.

Net sales during the period inched down approximately 1% year over year to $14,549 million, primarily due to a decline of 4% in comparable store sales. Each of Gap’s segments, including Gap North America, Banana Republic North America, Old Navy North America and International brands experienced a decline of  4%, 1%, 3% and 7%, respectively, in comparable store sales. However, total revenue beat the Zacks Consensus Estimate of $14,546 million.

However, despite weak top- and bottom-line performance during the fiscal, the company has some reasons to cheer. Gap is in the process of achieving its target of generating 30% net sales through International and Direct divisions by fiscal 2013. During 2011, the two segments contributed 26% toward net sales. Moreover, with efficient inventory management, the company delivered higher Average Unit Retails during full fiscal. Moreover, Gap has efficiently managed its costs and invested in pre-planned long-term growth initiatives.

Balance Sheet, Share Repurchases and Dividend

At the end of fiscal 2011, the company has cash and cash equivalents of $1,885 million compared with $1,561 million in the year-ago period and free cash flow of $815 million. In 2011, the company has made a capital expenditure of $584 million and expects to expend $600 million for fiscal 2012.

During 2011, the company deployed $2,092 million of cash toward share buybacks and $236 million toward dividends. Gap’s board of directors has authorized a new $1 billion share repurchase program replacing the previously announced share repurchase program of $500 million.

During the fiscal, Gap paid an annual dividend of 45 cents per share to its shareholders and announced to raise annual dividend by 11.1% to 50 cents in fiscal 2012.

Store Count

During the reported quarter, Gap opened 43 company-operated stores and shuttered 72 locations, bringing the total company-operated store counts to 3,036. Moreover, in the fourth quarter, the company opened 16 stores in franchise business bringing the total franchise store counts to 217.

In an effort to improve customer experience and boost productivity per square footage, the company plans to strategically close and consolidate square footage at Gap and Old Navy brands. In 2012, Gap intends to open 125 company-operated stores and shut down 115 company-operated stores in different locations. Moreover, it also expects to decrease net square footage by 1% in fiscal 2012. In 2011, the company’s net square footage decreased 2.6% from the previous fiscal level.

Contrary to this, the company is planning aggressively to expand its international and franchise business. Of the 125 stores to be opened in fiscal 2012, 55 stores will be opened outside U.S. Further, the company intends to triple the Gap store count in China from 15 to approximately 45 during the next 12 month period. Further, Gap also intends to open 10 Athleta stores in the country to a total of 50 Athleta stores.

2012 Outlook

The company now expects earnings in the range of $1.75 to $1.80 per share for fiscal 2012, an increase of 12% to 15% from fiscal 2011. The current Zacks Consensus Estimate stands at $1.80 per share, which is at the higher end of its guidance range. Moreover, Gap is also anticipating an increase of 10% in operating margin during fiscal 2012.

In a drive to boost international operations, Gap consolidated its foreign business under one division from London. Lackluster sales in North America compelled the company to explore business in other shores. In order to counter the domestic market saturation, Gap is aiming to generate 30% of total sales from its overseas operations and online business by 2013.

To achieve this end, Gap has opened its stores in China, Italy and Australia and has launched e-commerce business in more than 90 markets. These initiatives are expected to bolster the company’s top- and bottom-line performance, moving forward.

Our Take

We believe that the company’s long-term strategic moves along with disciplined cost management measures will not only provide financial flexibility, but will also help to drive value proposition. Moreover, Gap’s globally recognized brands complement each other, enabling it to leverage its position in the sector.

However, Gap operates in a highly fragmented market and competes with national and local department stores and discount stores, such as American Eagle Outfitters Inc. (AEO) and The TJX Companies Inc. (TJX), which offer products at fire sale prices. To retain the existing market share, the company may have to slash sales prices, which could affect its margins.

Gap’s shares maintain a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Our long-term recommendation on the stock remains ‘Neutral’.

 
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