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November 18, 2022

Gap Inc warns cost hike to hurt financial performance in 2023

Gap Inc has seen nine-month profit slide as a result of lower sales and higher costs and warns it will continue through FY23 as it anticipates higher wages and increasing supply costs.

By Hannah Abdulla

Higher cost of goods has eaten into Gap Inc’s nine-month profits with the retailer reporting a net income of US$71m compared with $272m a year earlier.

For the nine months ended 29 October, Gap Inc also booked lower net sales at US$11.4bn versus $12.1bn.

The Athleta and Banana Republic owner booked an operating loss of $39m compared with an operating profit of $802m a year earlier.

“I have deep conviction that we have a portfolio of iconic brands that our customers love, increased confidence in our platform to drive leverage and economies of scale, and belief in the team’s ability to deliver. We have sharpened our focus on execution to optimise profitability and cash flow, are bringing more rigour to our operations, and balancing our assortments in response to what our customers are telling us. While our efforts show early signs of improvement, we are clear that there is work to be done to deliver what our customers, employees and shareholders expect from Gap Inc.” said Bob Martin, executive chairman and interim CEO, Gap Inc.

Third Quarter Performance

  • Net sales rose 2% from $3.9bn to $4.04bn.
  • Gap Inc made an operating profit of $186m compared with $153m a year earlier.
  • And it turned a profit of $282m compared with the same 3 month period a year earlier where it booked a $152m loss.
  • On a reported basis, merchandise margin declined 480 basis points versus last year; adjusted for the impairment charge linked to Yeezy Gap, merchandise margin declined 370 basis points. Merchandise margins were negatively impacted by higher discounting and inflationary commodity price increases and partially offset by lapping last year’s higher air freight expense.

Brand Performance

Old Navy

  • Net sales of $2.1 billion were up 2% compared to last year. Sales growth was driven by improved size and assortment balance and product acceptance offset by softness in kids and baby category and demand from the lower-income consumer.
  • Comparable sales were down 1%.

Gap

  • Net sales of $1.04bn were flat compared to last year. Performance was driven by improvement in category mix balance and assortment balance offset by softness in the kids and baby category.
  • Global comparable sales were up 4%. North America comparable sales were flat.

Banana Republic:

  • Net sales of $517 million were up 8% compared to last year. The brand has maintained its focus on delivering quality product through a differentiated experience. It continued to capitalize on the current shift in consumer trends while realizing ongoing benefits since last year’s brand relaunch.
  • Comparable sales were up 10%.

Athleta

  • Net sales of $340 million were up 6% compared to last year. While the brand continues to make progress in driving awareness and establishing authority in the women’s active and wellness category, it continued to experience softness related to the shift in consumer preference from athleisure to occasion and work-based categories consistent with the broader athleisure market.
  • Comparable sales were flat.

“While our third quarter results underscore the initial progress we are making toward rebalancing our assortments and reducing inventories, we continue to take a prudent approach in light of the uncertain consumer and increasingly promotional environment as we look to the remainder of fiscal 2022”, said Katrina O’Connell, executive vice president and CFO, Gap Inc.

“In the near-term, we remain focused on the actions necessary to reduce inventory, rebalance our assortments to better meet changing consumer needs, aggressively manage and reevaluate our investments, and fortify our balance sheet. While we have work to do, we believe we are taking the right steps in order to position Gap Inc. for sustainable, profitable growth and to deliver value for our shareholders over the long term.”

Gap Inc Outlook

Sales: The company anticipates that total company net sales could be down mid-single digits year-over-year in the fourth quarter of fiscal 2022.

Gross Margin and Inventory: The company anticipates that air freight expense will continue to normalise and as it anniversaries approximately $245m of incremental air freight investment in the fourth quarter of last year, the company expects roughly 540 basis points of margin leverage in the fourth quarter of fiscal 2022 compared to the fourth quarter of fiscal 2021. The air freight leverage is expected to be offset by approximately 200 basis points of continued inflationary cost deleverage Gap Inc said. ROD as a percentage of sales is expected to be flat compared to last year.

While the company is taking actions to balance its assortment and right size inventory, the company has seen the most significant variability in its discount rate. Further limiting near-term discount rate visibility is the uncertain consumer environment and increasingly promotional environment. Gross margin in both the second and third quarters of fiscal 2022 was impacted by approximately 370 basis points of deleverage stemming primarily from higher discounting.

The company continues to target total inventories below prior year levels by the end of fiscal 2022 as a result of its inventory actions, reduction of receipts, and anniversary of higher intransit levels last year. By spring, the company expects to begin to capitalize on its responsive levers, providing the flexibility to better align inventory levels with demand trends.

SG&A:
During the third quarter, Gap Inc took initial action to reduce operating expenses, resulting in approximately $250m in annualised savings, of which an immaterial amount will be a benefit in the fourth quarter due to timing and severance offsets in addition to anticipated headwinds in the fourth quarter related to higher seasonal labour costs relative to last year.

While the company’s operating expense reduction actions are expected to benefit fiscal 2023, the savings are expected to be offset by more normalised incentive compensation and continued higher wage pressure next year.

Earlier this week, Gap Inc announced it was partnering with Amazon in a move that would see its brands sold on the Amazon Fashion platform in the US and Canada.

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