Q2 net income tumbled 43% to $168m, compared to $297m in the year-ago period.

Q2 net income tumbled 43% to $168m, compared to $297m in the year-ago period.

US specialty apparel retailer Gap Inc has reported another fall in comparable sales for the second quarter with negative results across nearly all segments of the business – and says it continues to closely monitor tariff discussions with contingency plans in place ahead of the upcoming List 4 tariffs.

Speaking on the company's second-quarter earnings call yesterday (22 August), president and CEO Art Peck addressed President Trump's plans for a 10% tariff hike on additional Chinese products including almost all textiles, apparel and footwear. 

The Tranche or List 4 tariffs will hit more than three-quarters (77%) of apparel, footwear and home textile products imported into the US from China from 1 September – amounting to about US$39bn worth of goods – according to an analysis by the American Apparel & Footwear Association (AAFA). The remaining 23% of apparel, footwear, and home textile products imported to the US from China will be hit with an additional 10% tariff on 15 December – amounting to about $12bn worth of goods.

"We do not think these tariffs have a constructive impact on the consumer," Peck told analysts, noting Gap is working to mitigate risk, but that rather than "speculate about contingencies, I'd just say we're focused right now."

Teri List-Stoll, Gap CFO, adds the retailer continues to "closely monitor the tariff discussions."

"Our teams have contingency plans in place for the back half related to the List 4 tariffs, including partnering with our vendors to share in the cost as well as pricing actions.

"On pricing, the teams are working on a targeted pricing strategy in certain categories where we have pricing authority versus a broad-based increase in pricing. The unmitigated impacts of List 4 tariffs would be an incremental $0.06 impact to our guidance based on current estimates. So through our mitigation and contingency plans, we would expect this impact to be much slower."

Peck says there are "various ways" to mitigate the impact of tariffs on the business. 

"Number one is sharing this with our vendors, which is where we're starting the conversation. Number two, certainly that we've looked at, is other places where we should be adjusting tickets and adjusting those either at the factory or in our DCs or in our stores. We have the capacity to do all of that. What I would also say is that by far the bigger lever is continuing to tighten up our inventories.

"Obviously, our first and foremost would be that we get into a more predictable environment where we aren't sort of constantly being whipsawed by what's going to happen tomorrow, but we're very flexible and we can deal with it as it comes along. We have a bunch of levers to deal with it."

Second-quarter results

For the 13 weeks ended 3 August, the retailer's net income tumbled 43% to $168m, compared to $297m in the year-ago period. The company's gross margin was 38.9%, a drop of 90 basis points compared with last year.

Net sales, meanwhile, were $4bn, a fall of 2% on the year before – with the translation of foreign currencies into US dollars negatively impacting the company's net sales by about $22m. 

Total comparable sales were down 4% compared with a 2% increase last year, with each of the group's brands recording a drop in comp sales in the period. At Old Navy Global, comps were down 5% versus positive 5% last year, while at Gap Global, comp sales declined by 7% versus negative 5% last year. Banana Republic Global comp sales were down 3%, compared to a 2% rise last year.

"We are operating in a challenging environment, but I remain confident in the strength of our brands and our plans for the future as we work to launch two independent, public companies," Peck says. "Heading into the second half of the year, we remain highly focused on inventory and expense discipline to improve results, as well as delivering exceptional product supported by powerful marketing to drive customer engagement."

Among the plans announced earlier this year, Gap is closing 230 of its namesake brand stores and spinning off its Old Navy brand into an independent, publicly-traded company. The group's remaining Gap, Athleta, Banana Republic, Intermix and Hill City labels will operate under a yet-to-be-named business.

Looking ahead, Gap continues to expect comparable sales for fiscal year 2019 to be down low single digits. The company updated its reported diluted earnings per share guidance for fiscal year 2019 to be in the range of $1.88 to $2.08 but affirmed its adjusted diluted earnings per share guidance range of $2.05 to $2.15.

Moving at a "glacial place"

Neil Saunders, managing director of GlobalData Retail, notes Gap's second-quarter is mostly a continuation of the first, with negative results across nearly all segments of the business.

"This is hardly surprising as the fundamental trading strategy has not shifted, so there is little reason to expect a different outcome," he says. "In this context we find the CEO's assertion that Gap is "running towards" the next step in its evolution as rather misleading. In our view, the company tends to move at what can best be described as a glacial pace.

The main issues continue to come from the Gap brand where products remain "firmly out of fashion with consumers."

"Our data show that shoppers are in retreat from Gap and, worryingly, discounting is becoming an increasingly ineffective tool in drawing them in to stores and online even to browse. Over the second quarter, some of this may have been down to the generally elevated level of discounting in the apparel market, but we also attribute the complete dearth of newness and inspiration within Gap ranges for the decline in shopper numbers.

"None of this is new. It is an old story that has been told time and again. However, our fear is that instead of bottoming out, the declines at Gap could accelerate if the consumer economy softens. When money is tight it is very easy for consumers to avoid spending at retailers that give them no compelling reason to do so – and Gap fits perfectly into this category."

At Old Navy, despite assortments going into the summer selling season being "less compelling than usual," GlobalData believes there is scope for Old Navy to make the necessary corrections as it heads into autumn. That said, a bad third quarter will throw up major questions as to whether the brand has lost its once golden touch – "a disastrous prospect for Gap as it looks to spin off the business."

Meanwhile, Saunders says improvements to quality and some better pieces within the Banana Republic assortment have helped to lift conversion and basket sizes from existing customers.

He adds: "While Banana remains a shadow of its former self, there is reason to believe it is on the road to recovery. That said, we do not think much of the initiative to get into the rental business. For a brand of Banana's price and position, we do not see rental as the right solution and believe the company would be better advised to continue focusing on developing compelling products and rebuilding its reputation."

Last week, the brand launched a new online rental subscription service – Style Passport – that provides unlimited access to its women's apparel collection. 

Away from the big three brands, Saunders says there are "clear signs of progress" with Athleta, which GlobalData believes is growing rapidly thanks to new store openings and good brand traction. "In our view, this business has good forward potential and over the next few years should make a more meaningful contribution to the company's growth and bottom line.

"Overall, the high-level view is that Gap is a company in retreat. Its profits and sales are in decline and it doesn't seem to have many credible plans to reverse that position."