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Gap Inc focused on refashioning for growth

By Beth Wright 05 Jun 2020

US specialty apparel retailer Gap Inc says it is using the coronavirus pandemic to right-size the business and build it for the future – acknowledging there is plenty of work needed at the eponymous Gap brand.

Gap Inc focused on refashioning for growth

US specialty apparel retailer Gap Inc says it is using the coronavirus pandemic to right-size the business and build it for the future – acknowledging there is plenty of work needed at the eponymous Gap brand.

The retailer – the largest specialty apparel company and second largest apparel e-commerce business in the US – operates brands including Old Navy, Gap, Athleta and Banana Republic.

But fortunes have varied widely across its portfolio, with demand for the Gap and Banana Republic brands failing to shift online despite widespread store closures due to the coronavirus pandemic.

“While there’s no playbook to manage the fallout, the situation required a radical shift in our priorities,” CEO Sonia Syngal told analysts yesterday (4 June) on the retailer’s first-quarter earnings call.

Steps have included a 15% headcount reduction across the company – edging towards a 25% reduction at the Gap brand – as well as using the pandemic as an opportunity to exit or renegotiate lease terms with landlords.

The company also said it worked with vendors to move from 45 days to 60-day to 90-day payment terms. It is also tightening purchases to demand, as well as utilising “pack and hold” inventory to preserve margin

This means summer and autumn inventory “that we will be unable to sell due to store closures and potentially lower demand will be held until next year’s selling season,” explained CFO Katrina O’Connell. 

“The pack-and-hold consists of either ongoing basics or summer product that was never delivered to stores that we can keep on hand. We can either access it to deliver to stores or we can hold that and assort it into next year.

“While there is a cost to storing this product, the economics are more advantaged than flowing the goods into what is likely to be a highly promotional environment.”

Turning to the Gap brand, Syngal admitted: “Gap has been a challenge for us.” Areas of focus here are leveraging online growth, right-sizing resources with the 25% headcount reduction, new products and segments like Gap team, and new opportunities like the recent licensing deal with IMG. This will introduce complementary products like baby equipment, home décor, and furniture to the Gap, Banana Republic, and Janie and Jack assortments.

“This is a great example of an asset-light, capital-light opportunity that delivers value for the customer and plays to the power of our brands.

“Lastly, we remain committed to our fleet rationalisation target, as our goal is to operate a smaller, healthier Gap brand positioned to compete.”

The executives admitted they are facing numerous unknowns – including customers’ willingness to resume shopping in-store, pent-up demand, recessionary impact from the pandemic once the benefit of stimulus money dissipates, the success of new items such as masks, and other distressed retailers who are aggressively trying to liquidate inventory. 

O’Connell also said the company is “modelling and preparing for” another possible wave of Covid-19 later in the year.

“We also remain committed to building toward our future. The unprecedented disruption experienced in the retail sector presents a very acute and unique opportunity. While everyone is adapting to a rapidly changing environment, we intend to lean into and apply our strategic advantages in order to gain customer loyalty and market share over time.”

So far the signs are that reopened stores in North America are already generating sales at nearly 70% of their performance last year, “with particular strength at Old Navy, where our customer base is strong and our store fleet is advantaged given its off-mall positioning. Online is expected to continue to grow strongly with some lumpiness as customers adjust back to having an in-store option.”

Q1 results

The comments came as Gap Inc swung to a US$932m net loss for the 13 weeks to 2 May, compared to net income of $227m last year, as net sales tumbled 43% to $2.1bn from $3.7bn.

Gap said solid momentum in the first 35 days of the quarter was more than offset by deceleration in demand as stores were closed. Store sales in the period were down 61%, while online sales increased 13% with growth continuing into the second quarter. 

At brand level, net sales at Old Navy Global were down 42%, with store sales tumbling 60% and online sales up 20%, while at Gap Global, net sales halved, with store sales down 64% and online sales falling by 5%. Banana Republic Global net sales, meanwhile, declined 47%, with store sales down 61% with online sales down 2%. At Athleta, net sales slipped 8%, with store sales were down 50% and online sales up 49%.

Gap did not provide comparable sales results for the quarter, noting the metric is not “meaningful” as a result of the temporary store closures.

Gross margin in the period was 12.7%, reflecting a $235m non-cash inventory impairment charge, rent and occupancy deleverage associated with store closures, and increased promotional activity. Beginning in April, the company suspended rent payments for closed stores. It says it remains in “active and ongoing discussions with its landlords,” adding its first-quarter gross margin reflects the cost of rent payments, which are being accrued for accounting purposes.

“Our teams’ ability to pivot quickly and lean into our strong online business resulted in an encouraging 40% online sales growth in April. While net sales and stores sales continued to reflect material declines in May as a result of closures, we saw over 100% growth in online sales during the month,” Syngal said in the group’s earnings release. “This online momentum, enabled by new omni-capabilities that have expanded the way customers can shop with us, leaves us well-positioned to fuel our brands going forward.”

The retailer has reopened more than 1,500 stores in North America, and expects to have the vast majority of its fleet in the region reopened this month.

O’Connell added that although store traffic and productivity are exceeding expectations, particularly at Old Navy and Athleta, the company continues to plan conservatively as “significant uncertainty remains ahead.” 

Urgent refocus

Neil Saunders, managing director of GlobalData Retail, notes that the negative headwinds and fallout from the pandemic mean a weak performance from Gap was to be expected. However, he says the 43% drop in sales is “more precipitous” than many of its peers in the apparel space – including Abercrombie and Urban Outfitters.

“In our view, this underlines the fact that the impact of the coronavirus crisis has been uneven, and more pain is being felt by already weak players, of which Gap is one.”

Saunders notes a 50% fall in Gap brand global sales, coupled with a 49% drop in the US, is a “terrible outcome” and the worst of all the group’s various banners. One of the reasons for such a sharp deterioration is Gap’s complete failure to transfer lost store sales online, he says.

“At a time when other retailers were almost doubling their online revenues, Gap’s e-commerce sales dropped by 5%. We believe this is indicative of the brand’s lack of traction with customers and its inability to stimulate loyalty. It aptly demonstrates that a fair proportion of sales are driven, not by a burning desire to visit and buy from Gap, but from chance visits to stores and impulse buys often stimulated by excessive discounting. As soon as stores are closed, Gap drops off the radar and consumers have neither the will nor inclination to shop the brand online.

“As we have noted so many times, the heart and soul of this problem stems from Gap’s anaemic ranges. These are bland and undifferentiated and do nothing to stimulate consumers. Against a market saturated with alternative apparel destinations, this simply isn’t good enough. Gap has been aware of this problem for an eternity but has consistently failed to act, either because it is too inert to do so or because it is unsure of how to correct the problem. In fairness, recent management changes may be the remedy to this, but the crisis has interrupted any progress that might have been made.

“Even before this crisis hit, we saw it as inevitable that Gap would shrink its footprint in the US and elsewhere. Given that the recovery in apparel will take some time to materialise and that Gap’s traditional discounting messages will be blunted by a raft of promotional activity in the market, we see more store closures as inevitable as the company takes a tighter grip on finances to undo some of the damage done by this quarter’s $1.2bn operating loss and the increase in borrowing.”

Looking to Banana Republic, Saunders says the dynamics at the brand are more excusable as it is exposed to the smart casualwear sector, which is heavily dependent on the world of work.

“As consumers stayed home during the pandemic, demand for Banana’s products dropped. Before the coronavirus hit, Banana was recovering thanks to better ranges and some more targeted marketing. The concern is that the recovery for more structured, smart apparel will be incredibly slow. As such, we believe that Banana will make a much less significant contribution to the group over the remainder of this year.”

Old Navy’s 20% increase in online sales “is still relatively low growth compared to rivals and did not offset lost store sales, but the brand’s casual products did well during lockdown. Moreover, its reopened stores, which are mostly in unenclosed malls, appear to be recovering faster than those of its sister brands.”

Saunders concludes: “Before the pandemic hit, Gap was in a weak position. It emerges even more withered with quite a lot of holes in its strategy. Solid brands like Athleta provide some hope but are too small to make up for the problems elsewhere. As such, Gap now needs to reinvent and refocus its efforts with an urgency that is unparalleled in its history.”