Gap Needs to come up with a Better Story

Retailer’s next challenge is to come up with a growth story as complete as its survival road map

By guest author Jinjoo Lee from Wall Street Journal

Caption and Graphic courtesy by Wall Street Journal

The Gap GPS -0.21% brand represents American optimism, its chief executive said on the retailer’s earnings call late Thursday. It could really use some right now.

Sales at Gap Inc., which shut all of its North American stores in mid-March, declined 43% in the quarter ended May 2 from a year earlier. That was 8.6% below analyst estimates and also worse than the 38% decline American Eagle Outfitters AEO +6.73 % saw during the same period. Its shares declined by a relatively modest 0.5 % in early trading on a strong day for stocks, perhaps reflecting how much bad news was already priced in.

Contrary to what the word pairing of retail and American optimism brings to mind, Gap’s call on Thursday, June 4, 2020, mostly offered a story of moderation and survival. The company highlighted that it had addressed its cash burn, cutting 15 % of its workforce—much of it at Gap, its flagship brand but also the laggard in the last couple of years.

It also furloughed some of its workers, deferred its dividend, cut capital expenditures in half to “recession-level lows” and bolstered liquidity. Its USD 2.25 billion debt raise in April, alongside cash preserving actions, bought the company at least two quarters of extra liquidity, according to RBC Capital Markets.

To conserve cash, the retailer also has skipped rent payments since April, though it still accrued them on the balance sheet for accounting purposes. Mall giant Simon Property Group sued Gap on Tuesday for failure to pay. While the lawsuit wasn’t mentioned in the call, the company said it was in “active and ongoing negotiations” with all of its landlords and could also just choose to shut some of its stores permanently—an effort that was already under way before the pandemic.

Its bright spot was online sales, which accounted for 25% of total revenue last year. Online revenue grew 40 % in April compared with the previous year and by more than 100 % in May. Reopened stores—55 % have resumed operations so far—are recovering at a slow pace, seeing sales below 70 % of their performance last year.

That is not everyone’s experience. Sales at reopened stores at off-price retailer TJX Companies exceeded the previous year’s level. Stronger sales were seen at Old Navy, its “value” brand that has heavier presence in strip malls, outlets and outdoor malls, while weaker performance was observed at the namesake brand and Banana Republic, both of which have heavier indoor mall footprints.

While Gap’s credit situation is far from ideal—the company is three notches into junk territory—it is still some distance away from default. Now bankrupt J.Crew Group, for example, already had been downgraded to CCC-, six notches below Gap, in September—long before the pandemic pushed it over the edge. That is some cause for hope, but Gap was already struggling with stagnant sales for several years, losing market share to off-price retail and fast-fashion chains.

Those challenges are still there,  and the pandemic is only going to make the emerging retail landscape tougher with excess clearance inventory. Gap’s earnings call, by necessity, had to be focused on details to ride out the worst case scenario. But if it wants to turn its sceptical investors around, it must come up with a road map to growth as compelling as the one detailing its survival.