While showing improvement in some areas, this narrow-moat retailer lost ground to others in the apparel market.
While showing improvement in a couple of areas, overall Gap
second-quarter performance was still marked with market share losses when compared with apparel category growth in the Gap and Banana Republic brands. The volatility in demand and continued struggles at two of the three brands reinforced our no-moat thesis. We continue to believe replicating the demand-driven supply chain used by Old Navy at Gap is strategically sound, but that management has failed to execute on this initiative. Therefore, we see little change in our $22 fair value estimate or our belief that Gap will continue to post low-single-digit average annual revenue declines and operating margin in the 8% range (versus 10% in fiscal 2015) over the next five years.
Bridget Weishaar is a senior equity analyst for Morningstar.
On the upside, the company continued to make progress in some of their initiatives. Consumers are still driven by value offerings, which should benefit Old Navy and Outlet sales. Work continues on establishing demand driven buying at Gap and management had examples of chasing some fashion products that worked well. Finally and most importantly, Old Navy returned to improved performance validating that a responsive supply chain makes fashion missteps less deep and more quickly corrected. Thus comparable sales improved sequentially, average unit retail was positive, merchandise margin was better, and inventory was tight.
However, overall performance still lagged. Second-quarter sales declined 1% on a 2% comparable sales decline with a 3% comparable sales decline at Gap and a 9% decline at Banana Republic offsetting flat performance at Old Navy. On the upside, adjusted operating margin declined only 50 basis points to 11.1% as adjusted gross margin remained flat at 37.7% in the quarter. Although we applaud the careful expense control, we are concerned that the company has limited room left to trim and that it will need to invest in marketing to support its improved merchandising.
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