A mixed print for GPS, but definitely net bearish with the price action heading into this event. A headline miss, though there are a lot of puts and takes in both COGS and SG&A where some perhaps could be one time, with management not giving specific non-gaap results. Revenue and gross margin beat, exceeding our expectations. Gap and Banana remained very weak, down 14% and 38% respectively, though both did see double digit declines in store count YY. Old Navy saw solid sales up 15%, perhaps unsurprisingly given it’s a big back to school retailers where there was pent up demand. Athleta also continued its momentum up 35% this Q. SG&A drove the miss, higher marketing spend and incremental Covid safety costs were the big drivers. The marketing is potentially a positive, but we’ll have to see if GPS can leverage that into good growth. Management is talking about added customers in the millennial/genZ demographics. That’s great, but they came in via online sales from digital marketing dollars being deployed. Those customers are a lot less sticky than ones that found their way into a store. 4Q guidance is pretty ugly with flat to slightly up sales, flat GM, and big SG&A deleverage, the sum of which comes to EPS ~30% below what the street was expecting.
The general commentary from management seems to imply a plan to invest in the brands. After all there were two new hires announced, Sandra Stangl to become the new head of Banana Republic, and Asheesh Saksena as Chief Growth Officer of total GPS. They most likely will be wanting to deploy capital to find growth opportunities for the brands. Our quick take on these two in their prior jobs? Stangl was a solid brand/business builder at Pottery Barn. Saksena heading up BBY healthcare spent a lot of money to buy assets that created a unique long term bull case around a new category, but have done little to drive value on the P&L and don’t have a clear path to long term success (if they did would he leave now to go to GPS?). Investing in the brand sounds good, but even if that even if that strategy is successful, it would mean several years of depressed earnings. We really struggle to get near the street earnings estimates in that context. You need either big revenue growth, which is difficult with door closures at two big brands, or you need big GM upside. There’s some savings from reduced occupancy costs on closed unprofitable stores, but the permanently higher ecommerce penetration means a notable hit to long term margin vs pre-covid levels. A rapid bounce back to 38%+ gross margin like the street assumes seems aggressive. Maybe some think Yeezy apparel could be the key, but to truly move the needle towards the high expectations, Yeezy would have to get real big real fast, like matching Athleta’s size in like year 2. That seems like a stretch. Then there is credit, which remains a question mark, both on near term impact given no disclosure from management, and on how the credit cycle will actually play out.
Even after store closures, we still see the core brands for GPS as structurally pressured businesses where profitable growth will be hard to find without big investment. Athleta is a solid asset, but it has probably 18-24 months of easy growth before it also starts to find driving strong incremental profits to be a challenge. GPS remains on our short bias list, we’ve been patient in elevating it given our view that trends into the 3Q print would be bullish and the street was likely to get more positive, that appears to have been the right move. Expectations are now much higher. Should the stock show any reversal from its after hours selloff GPS is a strong candidate to be a best idea short. On our numbers we see fair value around $10-$15.
For a replay of our Black Book on GPS: CLICK HERE
