Sales Gap at the Gap

It was a dismal December for retailers, but nowhere was the sales pain more acute than at Gap and Old Navy

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Ah, those balmy days of December. It wasn't exactly the greatest weather for holiday shopping or winter clothes, and the tepid monthly sales reports released Jan. 4 bore out many retailers' fears for a mediocre season. Deep discounting and consumers who waited to shop until nearly Christmas Day didn't much help, either.

But while upscale retailers like Saks (SKS) and Nordstrom (JWN) posted solid results in line with the fiscal resiliency of their more affluent shoppers, it was the other end of the economic spectrum that showed the flabbiest sales. And no apparel purveyor had a crueler December than the long-suffering Gap family of brands (GPS).

Sagging at the Seams

The clothing retailer's struggle to bring around Banana Republic continues while customer traffic falters at its other stores, Gap and Old Navy. Gap's sales at stores open more than a year fell 8% in December, showing results almost as bad as the same period of 2005, when they dropped 9%. Gap North America's sales at stores open more than a year fell 9% in December. It wasn't much better at the company's other brands. Banana Republic was the bright point, with a mere 2% gain. Old Navy's sales plunged 10%.

"Given the weak traffic trends, we needed to take significant action on promotions and markdowns at these two brands, which drove Gap Inc.'s overall merchandise margins significantly below last year," Sabrina Simmons, Gap's senior vice-president for corporate finance, said in a statement accompanying the dreary news. Also on Jan. 4, the San Francisco company cut its full-year 2006 earnings per share to between 83 cents and 87 cents, down from $1.01 to $1.06. The company is bracing itself for more pressure on its profits into January as it works to clear remaining holiday inventory.

"We are clearly disappointed with Gap and Old Navy's holiday sales and overall performance for the year," Chief Executive Officer Paul Pressler said Jan. 4 in a statement, pledging that his management team would again review Gap and Old Navy strategies to improve traffic and sales. "We are committed to making the necessary changes to improve performance." Pressler, a former Walt Disney (DIS) retail executive, is entering the fifth year of a thus-far flailing effort to right operations at the company, which has nearly 3,200 stores.

Takeover Dreams

In an effort to fix the sales woes, Pressler has been trying to give Gap a youth-oriented identity, but that took far too long to implement, according to Morningstar (MORN) analyst Joseph Beaulieu. Meanwhile, Banana Republic moved too far into trendy fashions and Old Navy moved too far into commodity discount clothing. And now "it doesn't sound like the new positioning for the Gap chain is solving problems," he says.

Despite the latest weak chapter in Gap's earnings, Wall Street didn't dump the stock. Gap shares rose 13 cents to close at $19.44 Jan. 4 on the New York Stock Exchange, fueled in part by the belief that Pressler could be replaced or that the company is a private equity target. Rumors have circulated for months that private equity firms have considered Gap a take-private fixer-upper. Despite its lukewarm sales, the company has respectable cash flow and Pressler has been able to cut the debt burden to $513 million last year from $1.9 billion in 2005. But Gap co-founder Donald Fisher and his family haven't shown any public interest in signing off on such a deal.