U.S. specialty apparel chain Gap, Inc. (NYSE:GPS) is expected to report lower earnings and revenues for its fourth quarter. But the stock could see upside in the coming days, driven by easy compares, lower product costs, leaner inventories and improved product.
Earlier this month, Gap guided its fourth quarter earnings in the range of 41 cents to 42 cents a share. Street expects the company to earn 42 cents a share, according to analysts polled by Thomson Reuters.
Gap has been struggling to entice consumers who are already feeling the heat of a slowing economy. The company's comparable sales for the fourth quarter were down 4 percent compared with a 1 percent increase last year. Meanwhile, higher cotton price and promotional events may hurt the company's gross margin.
The company also announced key management changes including the departure of Tom Wyatt, President of Old Navy, in January.
Gap, which operates Banana Republic, Gap, Old Navy and Athleta chains, is reducing square footage in North America and is on track to achieve a 10 percent reduction in overall store square footage by fiscal year 2012. On the other hand, the company expects to grow total sales outside of North America and online to about 30 percent by the end of fiscal 2013.
Jefferies expects Gap sales to improve in 2012 and margins to stabilize as the year progresses.
"We expect 4Q results to be in line with recent guidance and continue to expect an improving trend over the coming quarters. As such, we see GPS setting up for significant out-performance in 2012 as sales stabilize, margins improve, and sourcing costs moderate," analyst Randal Konik wrote in a note to clients.
After several quarters of disappointing topline results, the analyst expects trends to stabilize and improve this year, partially due to the easier compares the company faces. Meanwhile, the hiring of former executive Tracy Gardner bodes well for the continued fashion improvement in the Holiday/Fall 2012 season.
"We forecast margins to stabilize in 1H of this year and show significant improvement in 2H as the company laps easier compares," Konik said.
In the second half, Gap should see significant tailwinds from lower cotton costs given that about 75 percent of its products are cotton-based. Further, the company's entry in to the year with a leaner inventory should support margins. Konik, who has a "buy" rating and $28 price target on Gap shares, noted that the company's stock is trading at some of the cheapest multiples in specialty retail. Further, a strong balance sheet and solid cash flow with aggressive buybacks provide downside support to shares.