What Are The Problems Plaguing Gap Inc.?

While in the recent second quarter results Gap Inc (NYSE:GPS) beat analysts’ expectation on EPS and revenue, the results were still disappointing with over a 6% fall in EPS, a 24% decline in operating income, and a 43% drop in net income. The company also offered a downbeat outlook for the rest of the year, with a forecast of a full-year EPS to be in the $1.87 to $1.92 range, down significantly from its prior expectation of $2.20 to $2.25.

See our complete analysis for Gap Inc.

There are a number of issues the company has to deal with. Some of them have been highlighted below, and as will be seen, the first three problems are inter-related.

1. Pricing

One of the main problems the company has is the high initial prices it charges for its products. CEO Art Peck addressed this concern in May, when he stated the company was looking into the starting prices on its merchandise, with some changes being made across the Gap, Banana Republic, and Old Navy brands. However, this is a deep-seated problem, and one which cannot be solved overnight. According to Credit Suisse analyst Christian Buss, this would require a substantial overhaul of the supply chain, and would take years to fix.

2. Heavy Discounting

The company’s pricing problem extends further than its initial prices: Gap’s three main brands remain heavily discounted. As per research by Wells Fargo, during the second quarter to date, Gap and Banana Republic were more promotional than during the same period last year, while Old Navy was similarly promotional. In May, Peck did address this, and noted steps were being taken to curb such discounts. The competition from brands like H&M, which offer good quality clothing at lower prices, forces the company to offer discounts. However, if the starting price of the company is competitive, there will not be a need to furnish such heavy promotional activities.

3. Speed To Market

Fast fashion retailers, such as Zara, H&M, and Forever 21, are able to able to move styles from the runway to the stores within weeks, constantly evolving their assortment and keeping their products fresh. Historically, retailers placed their bets on fashion a year in advance, and since they marked their products higher, there was room for markdowns. However, now companies have realized that by cutting the time down to three to six months, they don’t need to price the items higher. As under the previous CEO Glenn Murphy, Peck is also looking to speed up and improve to the supply chain, and claims significant progress has been made to accomplish this.

4. Traffic

While consumers are still willing to spend their money, there has been a fundamental shift in what they are choosing to buy. Shoppers are increasingly moving away from spending on apparel, towards more spending on experiences, such as vacations, eating out, or a concert. This is reflected in the reduced traffic to malls and stores, and record spending on air travels, 8% rise in restaurant sales in the first eleven months of 2015, and growth in expending on media, which includes video games and streaming services such as Netflix and Spotify. This mindset change is proving to be a tough environment for retailers. Many have been trying to overcome this by sprucing up their outlets. For example, Urban Outfitters has opened bars and restaurants within its stores, Barnes and Noble has in-store cafes, and a Target store features a Starbucks. Vacations and dining out are expected to get a major chunk of the spending in the future, with a recent Mintel study pointing out an expected 27% increase between the years 2015 and 2019.

Have more questions about Gap Inc? See the links below:

• Gap Reports A Weak Outlook For FY 2016
• Fall In Sales To Weigh On Gap In The Second Quarter
• After Positive Results In June, Gap Returns To A Sales Decline
• Are There Signs Of A Turnaround At Gap, Or Is It Just A Blip On The Radar?
• Are Gap Inc’s Earnings Volatile?
• What’s Gap Inc’s Revenue & Net Income Breakdown In Terms Of Different Brands?
• By How Much Did Gap Inc’s Revenue & EBITDA Grow In The Last Five Years?
• What Is Gap Inc’s Fundamental Value Based On Expected 2016 Results?
• By What Percentage Can Gap Inc’s Revenues Grow Over The Next Three Years?
• How Are Gap Inc’s Old Navy Revenues & Earnings Expected To Grow Over The Next Five Years?
• How Are Gap Inc’s Banana Republic Revenues & Earnings Expected To Grow Over The Next Five Years?
• How Much Revenues Can Gap Inc’s Athleta Brand Add By 2020?

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