Gap Inc. Gets Another Downgrade
Gap Inc. was downgraded from “neutral” to “underperform” by Bank of America, which cited concerns about Old Navy, the biggest division at the retail corporation.
“We expect Old Navy to be disproportionately hurt by exposure to the low-income consumer and by worsening supply chain challenges,” BofA analyst Lorraine Hutchinson said in her report on Gap, issued Tuesday.
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BofA cut its 2022 earnings estimate for Gap by 48 cents to $1.59 and its share price target to $14 versus a previous target of $26.
Gap shares closed Tuesday on the NYSE up 12 cents, or 0.78 percent, to $15.49.
Earlier this month, Barclays lowered its Gap Inc. rating to “equal weight” from “overweight” and in January, Morgan Stanley lowered its Gap rating to “underweight” from “equal-weight.”
“Gap’s supply chain woes are well-understood, but while most expected conditions to strengthen post-holiday, retailers have commented that air freight prices have risen and ocean delays have not improved,” BofA reported Tuesday.
“Most retailers with low ticket prices have not used air because it is onerous to margins; Old Navy made the strategic decision to do so to avoid disappointing its customers,” the report indicated. “Additionally, there are still 77 ships waiting to dock outside the Port of Los Angeles, Long Beach as an expected lull in December deliveries wasn’t enough to offset Omicron-related slowdowns. This could lead to further receipt delays for ocean freight product.”
BofA said Old Navy accounts for 55 percent of Gap Inc. revenues.
Another concern cited was the lack of last year’s government stimulus checks and the outsized spending they sparked in the first half of last year. “This will likely be difficult to lap as pent-up demand is behind us and the consumer will have less incoming federal checks,” Hutchinson wrote.
“Management believes that market share gains from Old Navy will help support continued outperformance in the first half of 2022, but given Old Navy’s susceptibility to supply chain constraint inventory delays and the lack of stimulus benefits, we view the first half as especially challenging,” Hutchinson wrote.
She estimated that for the first half of 2022, Old Navy will see negative 8 percent to negative 3 percent comp sales, putting the brand back on its 6 percent three-year compound annual growth rate.
In the third quarter of 2021, Gap Inc. suffered $300 million in lost sales due to supply chain issues, along with an incremental $100 million in freight costs. “Old Navy was disproportionately affected by the 2.5 month COVID-19-induced shutdown in Vietnam as it sources more than other brands from the region, and has a higher exposure to West Coast ports amid the continued congestion and delay,” Hutchinson reported. But she added that “management has plans to digitize processes to enhance inventory management and flexibility, but benefits from the program aren’t expected to materialize until fall.”
Gap Inc. has guided to $350 million of air freight headwind in the fourth quarter of 2021, and $250 million to $350 million of supply chain disruption-related lost sales in the fourth quarter. “We think some of these headwinds will persist into the first half. This, combined with fixed cost deleverage on negative comps, should erase some of the merchandise margin progress the company has made. We also expect late deliveries to result in some markdown risk, despite having lower inventory levels.”
On the bright side, BofA said Athleta, which represents 10 percent of sales, has shown “continued strength,” adding that Athleta grew 15 percent in 2020 and 32 percent, year-to-date in 2021. In addition, BofA views Gap’s collaboration with the Yeezy brand as a “differentiator,” adding, “so far, the launches of a hoodie and a jacket have been well-received, helping to stabilize comps at the Gap brand.” Still, we don’t think Gap contributes to EBIT [earnings before interest and taxes] and we expect a larger sales recovery is necessary to improve margins.”
Gap Inc.’s balance sheet has been “fully repaired post-pandemic,” BofA noted.
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