For many years now, Old Navy has been the main growth driver for Gap (NYSE: GPS). Meanwhile, the namesake Gap brand has suffered a long string of sales declines.
Gap's management plans to address this issue by closing a substantial number of The Gap stores over the next two years, while also spinning off Old Navy to enable a greater focus on turning around the company's slower-growing brands. However, worsening sales trends cast doubt on the long-term viability of the iconic Gap brand.
Sales trends go from bad to worse
It's been more than five years since the Gap brand posted a full-year increase in comparable-store sales. Comps fell 5% in fiscal 2014, 6% in fiscal 2015, 3% in fiscal 2016, 1% in fiscal 2017, and 5% last year. Gap also trimmed its store count during that five-year period. The result was that global revenue for the brand has fallen 19% to $5.2 billion since peaking at $6.4 billion in fiscal 2013.
While Gap appeared to be steadying its sales trajectory a few years ago, sales are now falling faster than ever. For the first quarter of fiscal 2019, the Gap brand posted a dismal 10% comp sales decline. Including the impact of store closures, the brand's revenue fell 13% last quarter.
Bad weather certainly exacerbated Gap's sales weakness last quarter. The liquidation of the Gymboree children's clothing chain also weighed on sales of baby and children's apparel. That said, it's clear that the Gap brand is losing relevance as it fails to keep up with fashion trends.
Profitability is improving -- but is it sustainable?
The one bright spot in Gap's recent Q1 earnings report was that profitability improved at the Gap brand. Tighter inventory controls and a better merchandise assortment drove gross margin improvement, while the company worked hard to keep expenses in check.
Management hopes that an aggressive store closure plan will drive further earnings improvement. The Gap brand began fiscal 2018 with 725 specialty stores -- plus hundreds of factory and outlet stores -- globally. It shuttered 68 specialty stores last year and plans to close another 230 between fiscal 2019 and fiscal 2020. About two-thirds of those store closures will come at the end of fiscal 2019 and the majority of them will be in North America. All told, this program will reduce the number of The Gap specialty stores by more than 40%.
These store closures will lead to annualized pre-tax savings of $90 million. Additionally, they may improve the brand's health, since Gap has had to use big discounts to keep merchandise moving through underperforming stores.
That said, there's a limit to how far gross margin can rise -- and how far overhead and labor costs can be slashed. As long as revenue keeps declining, store productivity will continue to erode, making it harder and harder to cover the rent. Thus, investors can't count on continued profit growth without a sales rebound that seems as distant as ever.
The Gap could just fade away
Late last year, my colleague Rich Duprey suggested that Gap should just close its namesake chain's stores and transition the brand to an online-only retailer. However, doing so immediately could be prohibitively expensive, as Gap is locked into long-term leases for many stores.
On the other hand, as leases come up for renewal in the years ahead, it would make sense to close even more stores -- and management has signaled that it plans to do just that. These stores may not be making any money, but Gap would incur even bigger losses if it insisted on closing them this year.
That said, phased downsizing isn't really a long-term strategy. Store closures may shore up margins in the short run, but in the long run they will make the brand even less visible to consumers, driving further sales declines. Aggressive store closures and cost cuts should allow the company to wring out as much profit as possible from its namesake brand over the next few years. But a decade from now, there may be no financial or strategic rationale to keep the Gap brand around.
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