We applaud the retailer's improvements across all brands in product fit, quality, and aesthetic, but regaining customers will be a much more difficult and time-intensive undertaking.
By Bridget Weishaar | 11-17-16 | 06:35 PM | Email Article

Despite third-quarter adjusted earnings per share of $0.60 coming in ahead of our original estimate of $0.52, no-moat-rated  Gap's management maintained its full-year guidance for $1.87-$1.92 adjusted EPS. This highlights that industry traffic has decelerated thus far in November, marketing spend will rise across all brands, and bonus reversals from last year will be lapped. Although we applaud improvements across all brands in product fit, quality, and aesthetic, we continue to believe that regaining customers will be a much more difficult and time-intensive undertaking. Furthermore, having yet achieved a fully responsive supply chain, we think performance will be volatile and dependent on fashion design hits and misses with no consistent competitive advantage.

Bridget Weishaar is a senior equity analyst for Morningstar.

In the near term, we think Gap will benefit from easing comps, better product, and less discounting from leaner inventory levels, but that this will be offset by increased marketing spend, continued deleverage, and the impact of the distribution center fire. Therefore, we think adjusted operating margin will deleverage in the fourth quarter. In the long term, we think the lack of a competitive advantage in the overcrowded, highly promotional apparel space, compounded by shifts to e-commerce, will lead to flattish average annual revenue performance over the next five years and further adjusted operating margin decline from 10% in 2015 to the high single digits through 2020. We see little change to our $24 fair value estimate and view the shares as overvalued.

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