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

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.

"The stock is up because people are hopeful that, since things didn't turn around for the holiday like they were supposed to, maybe there'll be a change at the top," said Christine Chen, an analyst at Pacific Growth Equities. (The firm holds Gap shares, but does no banking or other business with the company.)

Discounters Bear the Brunt

In general, stores catering to consumers with the leanest wallets fared the worst, as shoppers worried about the housing market and scrimped (see BusinessWeek.com, 12/26/06, "Retail Results Signal Tough Times Ahead"). Plus, an unusually warm winter thus far in many parts of the country surprised retailers and kept items like heavy coats on their shelves, analysts say. Standard & Poor's index of 17 apparel retailers posted a 1.17% weighted sales gain at stores open more than a year, compared to 3.39% a year ago. (S&P, like BusinessWeek.com, is owned by The McGraw-Hill Companies (MHP).) Most of the losses in the index came from Gap; if that mammoth clothing retailer hadn't been included, the industry's overall value on the index would have come out slightly ahead of 2005 with a 3.82% gain.

Wal-Mart Stores' (WMT) U.S. sales at stores open more than a year gained 1.6% during the five weeks ended Dec. 29, down from 2.5% during the same period of 2005. It expects sales in the United States for the January five-week period to be up 1% to 2%. "We believe Wal-Mart is becoming more of a destination for electronics as consumers recognize that we have a leadership position on low prices," said Eduardo Castro-Wright, president and chief executive for Wal-Mart's U.S. store division. Wal-Mart shares rose 0.5%, to $47.78 per share, Jan. 4 on the New York Stock Exchange.

Wal-Mart battled to keep its sales up by offering hefty discounts on products like flat-panel TVs. Weeks before Thanksgiving, retail giants had begun duking it out for customers and dropping their prices on products such as high-definition TVs. Wal-Mart even offered 42-inch, flat-panel, high-definition TVs for $998 (see BusinessWeek.com, 12/13/06, "Static Ahead for Electronics Retailers").

Underlying Factors

Many economists see Wal-Mart's sluggishness as a sign that the low-income spectrum of the economy is hurting because recent jobs and income growth have favored the middle- and upper-income segments of the population. A report released this month by the National Low Income Housing Coalition found that the increase in the cost of modest rental housing in recent years has far outpaced that of the wages of minimum-wage earners (see BusinessWeek.com, 12/26/06, "Retail Results Signal Tough Times Ahead").

Wal-Mart is up against tough competition from Target (TGT). The Minneapolis discount chain said sales at stores open more than a year increased 4.1% compared to December, 2005. And Target is betting that its sales will increase in the range of 3.5% to 5.5% in January, 2007. Investors bid up Target by 41 cents, to $57.59 per share, Jan. 4 on the New York Stock Exchange.

"Both average ticket and traffic [at Target] increased during the month, we believe driven by holiday sales of electronics and frequent customer shopping trips for health-care, household, personal, and other everyday products," said S&P analyst Jason Asaeda in a research note. "While warm weather likely dampened demand for winter apparel, we think good inventory management has limited the company's markdown exposure."

Thriving on Luxury

Those who targeted the affluent fared better. Birmingham (Ala.)-based Saks, for example, posted an 11.1% gain in December at stores open more than a year. S&P upgraded the company to buy from hold, noting factors like its sales strength across major merchandise categories and ability to deliver luxury-focused products to customers. Saks shares slipped 4 cents to close at $17.96 Jan. 4 on the NYSE. Nordstrom sales rose 9%; its shares gained 1.7%, to $52.26.

"Certainly the luxury consumer is still out there, but it didn't help that the weather wasn't good" for retailers' apparel sales, said S&P analyst Marie Driscoll. The real question now is whether retail sales will remain chilly in January.


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