Gap Inc, the US' largest speciality clothing retailer, yesterday (21 November) showed the first signs of a turnaround under its new chief executive but failed to impress the market with a raised full-year outlook that fell short of expectations. As it heads into the all-important holiday season, Leonie Barrie looks at its latest plans.

Shares of the San Francisco-based company fell 6.1% to a low of $18.96 at the close of Wednesday trading, despite reporting a 26% hike in its third quarter profit.

For the three months to 3 November, net earnings rose to $238m, or $0.30 per share, from $189m, or $0.23 per share, a year earlier, as lower inventory and expenses helped offset a slowdown in same-store sales at its namesake Gap and Old Navy chains.

Third quarter net sales were flat at $3.9bn, while same-store sales - a key measure of performance that gauges growth at existing stores - fell by 5%.

"During the third quarter, we made progress in driving earnings growth by managing our inventory and reducing expenses," said Glenn Murphy, chairman and chief executive officer of Gap Inc.

Murphy, who joined the company at the end of July from Canada's largest drug store chain, Shoppers Drug Mart, added: "Our brands are focused on the upcoming holiday season and providing customers with a compelling store experience."

Divisional trends
By division, same-store sales at Banana Republic North America comped upward 1%, International fell 4%, Gap North American declined 7% and Old Navy North America dipped 8%.

In the year-ago third quarter, Banana Republic North America was up 3%, Gap North America down 7% Old Navy North America down 7% and International down 6%.

On the upside, the chain, managed to improve its merchandise margins by 100 basis points at its 3143 stores, as a higher per cent of goods were sold at regular price.

And third quarter earnings benefited from a $75m saving in marketing expenses, and an 8% reduction in inventory per square foot.

But there are fears that there is little scope for more cost reductions, with no cuts in marketing costs planned during the fourth quarter, and that the up upcoming holiday season is likely to be a tough one.

"We feel this is going to be a tough economic environment in this upcoming holiday selling season," Murphy said in a conference call with analysts.

He added: "We feel good that we've been disciplined on the inventory front and that we are becoming more and more conscious about our ability to reduce cost, and the consumer will ultimately be the judge."

Whether there are any opportunities to trim costs even further, though, remains to be seen.

Gap also may be under pressure to cut prices this holiday season, in an attempt to attract customers already concerned about the economy and higher oil and food costs.

Strategic steps
So far under its new CEO, Gap has taken a number of steps to streamline its operations and refine strategies. Among these was the closure of Forth & Towne after an 18-month launch, with around 550 Forth & Towne jobs eliminated in the first half of 2007.

Gap Inc also cut another 1,200 positions in the second quarter incurring costs of around $20m, mainly in severance payments.

In total, the company has eliminated about 2,200 positions during the first half of 2007, and says the majority of the job cuts are complete. Cost savings from this action are expected to be about $100m.

At the root of the company's problems, according to analysts, is its lack of inspired fashions and the need for a clearer understanding of its customers and the fashion directions that would bring them back and perhaps enlist new ones.

Earlier this year Candace Corlett, partner at WSL Strategic Retail in New York, said the company seemed unable to hit the right fashion note. "They've gone from jeans and white shirts and khaki pants to gold lame, and no one's really sure of what Gap stands for."

More worryingly, the competition is moving ahead and the Gap has been unable to keep up."

Refined design
In response, however, Gap has recently taken steps to refine its design teams by hiring Patrick Robinson, the Paris-based former artistic director of Paco Rabanne, to oversee the creative direction of its North American apparel, accessories and intimate apparel, and Todd Oldham as Old Navy's design creative director.

While these moves are widely applauded, however, the designers' influence is going to take months to show through.

Gap has also decided to shift its focus from younger consumers and instead target those in their late 20s, and teamed up with French shoe designer Pierre Hardy is to design a capsule collection for its European stores.

In fact, Gap is hoping its more fashion-conscious merchandise is enough to draw customers through its doors this holiday, and has shelved its usual marketing activities like high profile television adverts.

Instead, for the upcoming Black Friday (the day after Thanksgiving), its Old Navy stores will be open at 5am, and there will be weekly promotions to lure traffic. And Gap is planning a colourful Crazy Stripes line-up.

The retailer is optimistic its strategy will help raised full-year profit to $0.99 to $1.05, up from earlier guidance of $0.90 to $0.95 per share.