Gap, Inc. Stock: 5 Reasons We’re Staying Away (NYSE: GPS)

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The Gap, Inc. (New York Stock Exchange: GPS) operates as a clothing retail business. The company offers apparel, accessories and personal care products for men, women and children under the Old Navy, Gap, Banana Republic and Athleta brands. Its products include denim, t-shirts, fleeces and khakis; glasses, jewellery, shoes, handbags and perfumes; and fitness and lifestyle products for use in yoga, training, sports, travel and everyday activities for women and girls.

We published an article on Seeking Alpha in June 2022, titled: “Mind the Gap”. In this article, we have classified Gap shares as “sold”, due to poor first quarter financial performance, inventory management issues and overly high dividends. We’ve also highlighted some of the macro factors that are creating headwinds for the company, including consumer confidence and rising energy prices.

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Data by YCharts

Since our last article, Gap stock price is up 7%, outperforming the broader market, which is down 6%.

Today, we revisit Gap and provide an up-to-date view of the business, taking into account the latest news, developments and earnings release.

Let’s start with the latest earnings numbers.

Q2 financial results

Although the firm beat analysts’ estimates, financial performance in the second quarter, like the first quarter, was poor.

results table

Status of operations (GPS)

Sales fell, gross profit fell, margins shrunk, and as a result, the company’s net loss was $49 million, compared to a profit of $258 million in the prior quarter.

As noted by management, poor sales results were attributable to inventory delays related to continued global supply chain disruptions, persistent size and assortment imbalances and strategic store closures, as well as to an unfavorable impact of exchange rates.

On the other hand, the main causes for the increase in costs were: the increase in average unit costs, a result of the increase in air freight expenses and increases in raw material prices, as well as the increase in promotional activities and inventory write-down.

As we anticipated earlier, macroeconomic headwinds and inventory management issues continued to negatively impact Gap’s financial performance, contributing significantly to poor second quarter results. If we look at the previously mentioned macroeconomic factors, we can see that no dramatic improvement has occurred over the past few months.

Consumer confidence in the United States remained at extremely low levels, which could have a further negative impact on financial performance.

line chart confidence

US consumer confidence (Tradingeconomics.com)

While oil prices have come off their highs, they remain high. In addition, the recent announcement by OPEC+, regarding production cuts, makes the uncertainty around energy prices even higher.

line chart with price

WTI Price (Tradingeconomics.com)

We believe that weak consumer confidence will likely lead to a further decline in demand for Gap’s products, while high energy prices are expected to further drive up costs.

The company also withdrew its annual guidance, which may be related to the high short-term uncertainty, which we believe is quite troubling for shareholders and potential investors.

For these reasons, we see no justification for changing our bearish view on the stock.

Dividend

In August, the company declared a dividend of $0.15 per share. We believe this is not the best capital allocation in the current environment, especially considering the poor financial performance and net loss in the second quarter. We have already mentioned that dividends are likely to be unsustainable in the near future, so we interpret this news as negative.

If you are considering investing in Gap shares for the dividend, keep in mind that unsustainability may lead to reduced dividends over the next few quarters, which could also negatively impact the stock price. stock.

We can also see that many GPS competitors and peers do not pay dividends, or those that do pay, have significantly lower payout ratios. It also signals to us that a dividend cut may be on the horizon for GPS.

dividend statistics table

Dividends (Looking for Alpha)

Departure of the CEO

In July 2022, the company’s CEO unexpectedly resigned. Such events are often a signal that the company is not moving in the right direction. In our opinion, this can be a warning sign and should not be ignored by investors when making an investment decision.

cutting jobs

In September, the company announced plans to cut 500 corporate jobs as a cost-cutting measure. While job cuts can be an effective cost-cutting measure, it’s likely just another warning sign that the company is in financial trouble.

Financial ratios

Evaluation

The following chart compares some of Gap’s key valuation ratios with its peers.

assessment board

Evaluation (Looking for Alpha)

We can see that both in terms of P/E and P/CF, GPS is trading at a significant premium to its peers. We believe that such an overvaluation is not justified, especially in the current market environment. For this reason, in our view, there is substantial downside risk at current price levels.

Profitability

Additionally, profitability ratios indicate that GPS is relatively unattractive compared to its peers.

profitability table

Profitability (Looking for Alpha)

EBIT, EBITDA and net income margins are much worse than those of its peers. All of this shows that the company is doing much worse than its competitors in terms of converting their sales into profit. Another reason why the valuation is not justified, in our opinion.

Balance sheet ratios

balance sheet

Balance sheet (MRQ) (Looking for Alpha)

Current and quick ratios give an indication of a company’s financial flexibility and ability to meet short-term financial obligations. We prefer companies that have current and quick ratios greater than one, which means they have more current assets than current liabilities. As we can see, the GPS is well below 1, in terms of quick ratio, and also compares poorly to its peers. This could mean that GPS could have problems in the near future, especially if the headwinds mentioned above continue over the next few quarters.

to summarize

In our view, the company’s financial performance remains poor. Net sales and profits have declined, while costs have increased. The macroeconomic environment remains difficult, which should further negatively impact Gap’s performance in the short term.

Declaring a dividend, while reporting a net loss, is an unattractive and unsustainable way to allocate capital.

The unexpected departure of the CEO could be another warning sign that the company is in trouble.

The company compares poorly to its peers and competitors, in terms of valuation, profitability and balance sheet ratios, which makes Gap an even more unattractive investment option.

For these reasons, we are maintaining our “sell” rating.

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