The Gap Downgraded At MKM, Stock Has 'One Too Many Cracks'

• Gap Inc GPS shares have lost 31 percent year-to-date, declining steadily since early-April.
• MKM Partners’ Roxanne Meyer downgraded the company from Buy to Hold, while reducing the Fair Value estimate from $40 to $29.
• Meyer mentioned that the company could report severe gross margin erosion in 3Q, with disappointing results across brands.

Analyst Roxanne Meyer said that Old Navy’s September comp miss reflects more than a weather impact. It reflects a “less favorable response” to the product, which creates a tough backdrop into the holiday season.

In the report MKM Partners noted, “We assume that Old Navy is contributing to the expected gross margin decline in 3Q given its magnitude of about 270 bp.”

The September shortfall may be indicative of softer comps ahead for Old Navy “at a time when compares toughen significantly,” Meyer wrote. It could also indicate that margins at Old Navy margins do not represent “a continued expansion opportunity as we had anticipated from the continued roll-out of fabric platforming.”

Referring to Banana Republic, Meyer said that the decision to remove Marissa Webb as Creative Director likely reflects a “downtrending business into 2016” from a comp and margin perspective. Substantial markdowns required to clear fall product may have also caused the margin contraction in 3Q.

Gap’s September comp was clearance driven, and little could change until Spring next year. The closing of underperforming stores would boost margins in 2016.

The EPS estimates for 3Q and 2015 have been reduced from $0.78 to $0.62 and from $2.77 to $2.50, respectively, to reflect lower sales and gross margin. The EPS estimate for 2016 has been reduced from $3.06 to $2.80 mainly to reflect “a more modest gross margin rate increase.”