We're biased short side on GPS, and we reviewed the reasons why while evaluating the bull and bear case in our black book GPS | Cheap, or Big Value Trap?. For a replay CLICK HERE
One of the points we made in our presentation was highlighting the risk to GPS's P&L from its credit card income. In our presentation we mentioned it was interesting that two important value drivers for the stock, Athleta and credit, are booked in Other revenue. But GPS actually changed its revenue reporting to move credit card income out of other revenue this fiscal year(detail in image below). We suspect the revenue has now been allocated to the various brands according to which banner's store the card it is associated with, though it is not clearly stated that this is the case. Our estimate of 2019 credit revenue is ~$420mm, which is a significant amount. The change was done rather subtly, and without restatement of past quarters. That begs the question, why make such a change? Here are our thoughts on the potential reasons.
- It provides a cleaner look at Athleta - Removing credit from Other means that Other revenue more closely reflects Athleta, and investors care about Athleta, so perhaps one could make the argument that is management's rationale. This would be the most unsuspecting reason and it's probably not accurate, because the easier way to give a clear view of Athleta would be to simply breakout Athleta as its own brand segment like Gap or Old Navy.
- It boosts the growth of one of the brands - Shifting the revenue from other into the larger brand segments would make the growth rate of a brand look moderately better. Old Navy for example could be seeing 250-300bps of incremental growth in the segment from the shifted revenue. It's not huge, but could be the difference between 3Q being up vs being down.
- It hides the significance and potential decline within credit this year - This is the most likely reason from where we sit, especially given the timing of the reporting change (before 1Q). Management likely expected credit to get ugly in 2020, something they should have known was a huge risk whenever the economic cycle ended. With the volatility in sales, it was an easy time to make the change without much to be noticed. If the company left it in Other, management would likely have to be fielding question about what was going on in Other all year, was it a problem with Athleta? The execs would not want to make credit such a big focus of earnings events because it would reveal how much of the earnings stream comes from acting like a credit card issuer vs a retailer. That's likely a scenario management wants to avoid.
We think there is still significant risk to the P&L for GPS (among other retailers) within the credit portfolio as the credit cycle rolls. It looks like it will be happening at a time when consensus numbers expect continued earnings improvement, which could mean some surprises on earnings in the next few quarters.
