Gap downgraded as Banana Republic sales extend their decline

Gap Inc. stock was downgraded to neutral from buy at MKM Partners Friday, following some weak September same-store sales numbers, led by Banana Republic, which has seen double-digit declines for a string of months.

Banana Republic same-store sales fell 10% in September, after rising 2% last year. Same-store sales for August were down 11% after a 10% decline for July.

Same-store sales compare sales at stores that have been open for at least a year. It’s a key metric for retailers that offers an apples-for-apples comparison by excluding any changes caused by new store openings.

Adding to the bad news, Banana Republic’s creative director Marissa Webb will transition to a creative adviser role. She was appointed in April 2014.

The company won’t be filling the creative director position at this time. It’s the second major executive change at Banana Republic this year, after Andi Owen became global president on Jan. 5, succeeding Jack Calhoun.

There have been three other executive changes in the past 12 months for Gap Inc.
as a whole: Gap announced that Stefan Larsson was stepping down as Old Navy brand president on Sept. 29 to become chief executive at Ralph Lauren Corp.
Chief Executive Art Peck replaced Glenn Murphy in February, and Jeff Kirwan replaced Stephen Sunnucks as global Gap brand president in Dec. 2014.

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“While we had anticipated that trends at Banana Republic would remain challenging at least until holiday, the decision to remove Marissa Webb as creative director after only six months of her product selling not only reflects CEO Art Peck’s quick decision-making and sense of urgency to improve the business, but likely also reflects a downtrending business into 2016 from both a comp and margin perspective,” MKM Partners analysts wrote in a note.

The firm cut third-quarter earnings per share estimates to 62 cents from 78 cents and fourth-quarter earnings per share estimates to 68 cents from 79 cents. It lowered its 2015 earnings per share estimate to $2.50 from $2.77.

“[The] drag from Banana Republic [is] likely more severe and will last longer than we anticipated,” the firm wrote.

The problems at Banana Republic might be summed up in one word, said Marshal Cohen, chief industry analyst at The NPD Group, coining the term, “casualization.”

“As we look around and see how people are dressing, more and more we’re practically wearing our pajamas as streetwear,” said Cohen, who also highlighted the athleticwear, or “athleisure” trend, in his comments.

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“Banana Republic’s customer has gotten much more casual,” said Cohen. “They went from spending with them to spending everywhere else.”

The competition includes fast-fashion retailers like H&M Hennes & Mauritz AB
which offers casual clothing and more formal outfits at lower price points.

“Now the consumer has the ability to find fashion at a great price elsewhere,” said Cohen. And these days, when a shopper gets a good deal, they can “be proud that [they’ve] paid less.”

Banana Republic makes up less than 20% of the Gap Inc. portfolio, said Jennifer Poppers, spokesperson for Gap Inc.

“September results were disappointing,” said Jack Calandra, Gap senior vice president of corporate finance, who called out Banana Republic’s women’s business during his comments on Thursday.

The brand is focused on changing its collection to one that strikes a balance between consumer trends and its refined reputation, said Poppers.

“The team has been focused on buying an assortment that is both commercial and fashion oriented,” said Poppers. “They were able to affect some change starting with the holiday collection, with more of an impact in 2016. ”

Banana Republic presented its Spring 2016 collection last month.

“[W]e believe the deceleration was driven in part by some fit issues in bigger categories,” said Poppers.

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September net sales for Gap Inc.’s three brands—Gap and Old Navy are the other two—were down 1% to $1.46 billion from $1.48 billion last year. Same-store sales were flat at Gap versus down 3% last year. Same-store sales were up 4% at Old Navy versus a 1% increase last year, but that missed RetailMetrics’ 5.6% estimate.

And there are concerns about the company’s gross margin for the third quarter. The company is trying to “enter the critical holiday season with clean inventories,” according to Calandra.

“We assume that Old Navy is contributing to the expected gross margin decline in the third quarter given its magnitude of about 270 basis points,” the MKM note said. “The shortfall in September could point to softer comps ahead for Old Navy at a time when compares toughen significantly.”

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