Gap's (GPS) Canceled Spin-Off Aids, Transformation In Focus

Gap Inc.’s (NYSE:GPS) recent decisions, which include the revocation of its planned Old Navy spin-off into a separate entity, drive the stock. Further, it is focused on efforts to transform its namesake and Banana Republic brands.

Notably, the company witnessed positive margins and traffic trends for the Gap brand in third-quarter fiscal 2019, owing to its efforts to drive profitability through improved product assortment and inventory composition as well as reduced promotions.

Gains from these are well reflected in the quarterly performance and share price movements of the apparel retailer. The Zacks Rank #2 (Buy) stock has gained 1.8% in the past month against the industry ’s decline of 2%. This was mainly due to the momentum witnessed after pulling back from the Old Navy spin-off. Further, the company has rallied 7.4% in the past three months.

Gap Calls Off Old Navy Spin-Off

Gap canceled its plan to spin-off Old Navy into a stand-alone public company. The board of directors stated that the costs and complexities of splitting into two companies as well as soft business performance made the spin-off unfeasible.

The spin-off was proposed to create value from the company’s portfolio of iconic brands. However, Gap expects the aforementioned costs and complexities to hinder the creation of appropriate value from the separation.

Following the revocation, the company plans to focus on transformational efforts to further bolster its growth brands, Old Navy and Athleta. Meanwhile, it expects to focus on boosting the profitability of the Banana Republic and Gap brands. The company intends to support these efforts through the appointment of new leadership team for its retail portfolio.

Revocation to Aid Fiscal 2019 Results

Citing gains from the cancellation of the spin-off, the company raised its guidance for fiscal 2019. It now anticipates comparable sales and net sales to be at the higher end of its previously mentioned ranges. Earlier, it predicted comparable sales decline in mid-single digits and a dip in net sales in low-single digits.

Moreover, based on the enhanced promotions during the holiday period, particularly for the Old Navy brand, for fiscal 2019 the company now envisions adjusted earnings per share to be moderately higher than $1.70-$1.75 mentioned earlier.

Further, the Zacks Consensus Estimate for Gap’s fiscal 2019 and 2020 earnings has moved up 4% and 1.8%, respectively, in the past 30 days.

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Transformation Efforts

Management remains on track to revitalize the Gap brand by streamlining its specialty fleet and enhancing the marketing model to drive customer engagement. The company is also focused on driving profitability through improved product assortment and inventory composition as well as reduced promotional activity. Notably, it reduced big box promotional events and adopted flexible promotional messaging. It is also working to streamline online and offline promotional activity by bringing pricing transparency. This will likely help build customer confidence and boost the brand’s image.

The brand is also focused on re-establishing its authority in denim, as clear from the recent launch of the marketing campaign, “Its Our Denim Now”, which received positive customer response.

Although the Gap brand reported a comps decline in the fiscal third quarter, traffic trends were positive across all channels on continued improvement in customer response to products. Further, the brand reported the third consecutive quarter of improved margin rates in the fiscal third quarter. This marked the first quarter of margin expansion across all major product categories — including women's, men's, and kids and baby — as well as positive global average unit retail.

Further, the Old Navy brand remains a significant long-term growth opportunity for the company. Gap remains confident about Old Navy’s growth potential, driven by better execution of its unique value equation and positioning, with style, fit, quality and price working in balance. Additionally, Gap has been experiencing significant progress in its smaller brands like Hill City, and Janie and Jack. The company also remains focused on its growth brands, with more store openings for Athleta, Old Navy and Gap China.

Conclusion

In all, Gap looks poised to gain from the recent pull back from the Old Navy spin-off and ongoing transformational efforts. We believe that retaining Old Navy and efforts to revive the Gap brand pave the way for long-term growth.

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Written By: Zacks Investment Research