The Gap Inc. (GPS - Analyst Report) posted second-quarter fiscal 2015 results, wherein its adjusted earnings of 64 cents a share came in line with the Zacks Consensus Estimate and matched the upper end of the company’s guidance range of 63–64 cents.

The Gap Inc. - Earnings Surprise | FindTheBest

Including the effect of strategic actions, the company’s GAAP earnings slumped 30.6% year over year to 52 cents a share, owing to delays due to labor disruption at the West Coast ports, foreign currency headwinds and the strategic undertakings announced on Jun 15, 2015.

Management highlighted that foreign currency fluctuations reduced the company’s earnings per share growth by approximately 5% during the reported quarter.

Net sales of $3,898 million dropped 2.1% from the year-ago figure and missed the Zacks Consensus Estimate of $3,927.8 million. Results for the quarter included an impact of nearly $100 million from foreign currency translations, primarily due to a weaker Japanese yen and Canadian dollar against the U.S. dollar. On a currency neutral basis, sales for the quarter remained flat year over year.

The company’s second-quarter sales results reflected growth for another consecutive quarter at Old Navy. Additionally, the company continues to carry out the strategic plans slated for the revival of its Gap brand.

Comparable-store sales (comps) for the second quarter declined 2%, compared with flat comps in the prior-year quarter. Brand-wise, comps at Gap Global fell 6% compared with a 5% decline in the year-ago period, while comps for Banana Republic Global decreased 4% as against flat comps last year. On the other hand, comps for Old Navy Global rose 3% compared with a 4% increase in the prior-year quarter.

Gross profit declined 7.1% to $1,458 million, with gross margin contracting 200 basis points (bps) to 37.4%. This was attributable to deleverage of rent and occupancy expenses, and merchandise margins which were battered by port and currency headwinds.

Operating income plunged 34.9% to $396 million, while the operating margin shriveled 470 bps to 9.5%, owing to lower gross margin coupled with higher operating expenses. However, marketing expenses reduced by $11 million to $131 million in the reported quarter.

Financials

Gap ended the quarter with cash and cash equivalents of $1,043 million, long-term debt of $1,328 million, and total shareholders’ equity of $2,671 million. During the first half of fiscal 2015, the company generated cash flow from operations of $642 million and incurred capital expenditures of $301 million, resulting in free cash flow of $341 million.

Management continues to project capital expenditures of approximately $800 million during fiscal 2015, to be allocated primarily toward enhancing omni-channel and supply chain capabilities.

Gap’s total return to its shareholders for the first half of fiscal 2015 amounted to $800 million, via share buybacks and dividend payments. During the reported quarter, the company bought back 10 million shares for roughly $375 million. Further, the company paid a quarterly dividend of 23 cents in the quarter.

Also, on Aug 23, the company declared a dividend of 23 cents for the third quarter of fiscal 2015.

Store Update

In the second quarter, the company introduced and closed 35 company-operated stores, each. Also, it opened 7 franchise stores, while shuttering 5. Gap ended the quarter with 3,751 outlets in 51 countries, of which 3,309 were company-operated and 442 were franchise.

In fiscal 2015, management intends to remain committed toward store growth, with primary focus on Asia, Athleta and global outlet stores. However, owing to the closure of Gap brand outlets, the company now expects square footage growth to remain flat in fiscal 2015, compared with 2.5% growth expected earlier.

Outlook

Gap retained its fiscal 2015 earnings per share forecast of $2.75–$2.80. This excludes the impact from strategic actions, which include estimated charges of roughly $130–$140 million. Earlier the company expected these charges to range from $140–$160 million.

Further, management continues to anticipate a 100 bps decline in the operating margin (excluding costs related to strategic actions) for fiscal 2015 from the fiscal 2014 level.

Zacks Rank

Currently, Gap carries a Zacks Rank #3 (Hold). Better-ranked stocks in the apparel-shoe industry include American Eagle Outfitters Inc. (AEO - Analyst Report), with a Zacks Rank #1 (Strong Buy), DSW Inc. (DSW - Snapshot Report) and Citi Trends Inc. (CTRN - Analyst Report), each carrying a Zacks Rank #2 (Buy).

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