The Gap, Inc. (GAP) Earnings Call Transcript
June 2, 2021
Earnings Call Speaker Segments
We have with us today from Gap, Inc. CEO, Sonia Syngal; and CFO, Katrina O'Connell. Thank you both so much for being here. Before we jump into the Q&A portion of the meeting, I'm going to turn it over to Sonia for some opening comments.
Thank you, Beth. Hi, everybody. We're happy to be here. And Katrina and I are looking forward to talking about what we're working on here at Gap. And I think that for us, driving against our Power Plan 2023, which we laid out last October, is taking hold. And it's grounded in the power of our brands, these 4 incredible values-driven, iconic American brands, $1 billion plus revenue; the power of our platform, which is all about the operational and technology prowess that the scale of our business allows us and is a factor in our acceleration; and then the power of our portfolio, with these 4 brands addressing 80% of apparel end-use as well as our customer file that's 188-million strong. So that's the core tenets of our strategy. We are really pleased about our Q1 results and also about reinstating our dividend with the cash generation that we've seen and the health that's back in the business. So with that, happy to take any questions you might have, Beth.
All right. Great. Thank you for that context. I guess I just wanted to kick it off with a big picture question on the consumer. So consumer balance sheets are generally pretty healthy right now. And of course, there's this heightened demand for clothes as we all emerge from our houses. Curious how you think about the longevity of this eagerness to spend on the part of the consumer. Is this a matter of weeks, months, quarters, years? How do you think about it?
Yes. I think the consumer is in a good place. As you know, between the savings rates and the stimulus and spending in the post-COVID exuberance, as you've said, Beth. And we're seeing the power of the "and" show up in our business, right? The staying-in clothes, the going-out clothes, the workout as well as the dress up. And so all of that is happening. How long that lasts, I think -- we think it will be here for a while. Certainly, there's a different range of forecast. People believe it will be enduring in the out-years. So more than a quarter, more than a year. We think it could be a new -- a wave, the roaring '20s wave, if you will, that's one school of thought. For us, the way we are planning for the environment is to be ready in any situation. Because we believe underneath it all, our performance is being driven by our strategy, first and foremost, and is buoyed by the consumer. But it's really our Power Plan strategy that's driving the performance that we're seeing and the market share consolidation that's happened and grown for the last 3 quarters for us.
Got it. Okay. And then just in terms of stimulus, I get that it's difficult to quantify. But just curious, on the most recent quarter, how do you think about the magnitude of the impact, particularly at Old Navy, but maybe across the other brands as well?
Yes. Katrina, do you want to comment on the -- yes, that would be great.
Yes, sure. We haven't publicly quantified it. We would say that, certainly, it was a tailwind in the quarter. That, combined with the earlier rollout of the vaccines, which I think surprised us all and really helped to get the stores, in particular, open faster to consumers than we had expected. And the history would say that, yes, Old Navy has, in the past, benefited more from stimulus. But I think what Sonia said is true, which is even though we carve off a little bit of the tailwinds for stimulus and the faster rollout of the vaccines, fundamentally, we believe that Old Navy and Athleta, in particular, are benefiting from the market share consolidation they've done in their key categories, the strength of those brands and the health of the way they've been competing. And then I'm sure you saw that our Gap North America comp was a positive [ 9 ], which also tells us that there's health -- I think what Sonia said is healthy, growing and cool that brand here in the U.S. and Canada. And so all of our brands are doing well, with Banana coming up quickly. And some of that is stimulus, but a large part of that is just great execution on the creative end product.
Got it. I was actually just going to ask on Gap North America. And specifically, what's driving this positive momentum. It sounds like most of it's on the product side. And then I guess, just any color there. And then as well as are you seeing signs that -- in terms of that brand, that consideration is moving in a positive direction relative to brand awareness?
Yes. Thanks, Beth. Listen, I'd love to talk about our brands. It's the core tenet of our strategy. And what is a brand? So a brand is very simply 3 things: it is marketing that is purposeful and purpose-led. And The Gap doubled down on that creative clarity, and you're seeing that cut through, you're seeing that marketing cut through. And then it is the product, of course. And the product has to be great. It has to be great against the value equation that our customers demand, right, which is a great style, a great fit, great quality, sustainability, which is a core tenet to Gap's product as well as price. And then it is about the power -- about the experience, the digital experience and the physical experience. So what Gap has done is raise the game on all of those dimensions, right? In addition to the hard, hard restructuring work that has been needed, the shedding of the unprofitable stores, the strategic review of our international markets, which have been underproductive for us. And it is about excellence at the core tenets of brand management that I've articulated. So the marketing we've invested in, both the creative execution as well as more of it, has been key. The product, particularly the adult product, I'm really pleased with the leadership team that we put over the adult product, which has been -- that had been leading our kids and baby product for Gap, had a proven track record, and we're seeing that take hold in the adult side. And in kids and baby, gap is the 6th largest U.S. retailer and certainly with the reach around the world -- our largest brand with reach around the world. So a very strong component was their kids and baby business. And now the whole product line, we believe, is heading in the right direction. And then the experience. So the digital site, if you've been on it lately, it looks cool, it looks relevant. It's also much less friction, much more efficient and great new capabilities, that's all of those technology investments we've been making for the entire company. And then the physical experience, the stores. Our go-forward fleet is now light, bright and happy. We've invested in remodels. We're more than halfway done with a go-forward fleet and we plan to get the rest complete. So we're focused on the fundamentals and excellence at the fundamentals. And I think you're seeing that now in the performance of the brand in North America in particular.
Yes, certainly. And then just on the Old Navy, also, clearly, a great quarter. And on kids and baby, you had talked to share gains there as some retailers in those categories go out of business. But also curious, what other key categories are you taking share in Old Navy? And then maybe just some color on the intimates launched in April and how that's doing, albeit early days.
Yes. Thanks, Beth. I think one of the biggest areas that would maybe double down on with respect to product was the Active and Fleece business. So anything cozy as well as active. And they distorted in a pretty material way. They called it right at the beginning of COVID. They already had strength there. And now you'll see it, that's where they've seen the biggest gain. And Old Navy is actually the fastest-growing active brand in the U.S. based on how much that has accelerated. It is north of -- it's about a $2 billion business as a part of the Old Navy business and growing very fast. By the way, active, as you know, is the category that's growing the fastest within the apparel sector at large. So active matters. Kids and baby, as you mentioned, very, very important for Old Navy. They are neck and neck with the top brand in the U.S., and we think we'll outstrip that. Old Navy and Gap combined are about 10% of the U.S. kids and baby market share. And so as we head into back-to-school, we think a pretty major area of acceleration for us there. And then certainly, all of the fashion product, right? Old Navy has always been known for family, fun, fashion and value. All the fashion product, the dresses, the shorts, the Fourth of July wear, great execution there. The dresses business, all of those have been top search items for us as COVID has receded and spring and summer have emerged. So they're really going from strength to strength on product. And then category extensions, whether it is the intimates launch, very quiet intimates launch in April that already has them at the top 20 intimates brands in the U.S. and that'll build. And then the body inclusivity launch that they have planned for fall, which we think will be a very, very big game changer for them as well. They've had a very good online business with extended sizing to take that to their fleet of 1,300 stores roughly. It's going to be something to watch. And they've worked for a few years to make sure to get that right.
Okay. And it doesn't sound like it. But as we're buying more going-out clothes, if you will, are there any shift away from the activewear side of the business?
We're seeing "and." I don't know about you, Beth, but I feel like I'm excited to go out and then I cannot wait to run home and put on my sweatpants again, right, after I've worked out. It's a little bit of what we're seeing. And the consumer behavior is this "and" factor, the party dress and the sweatpants and the active gear. And we expect that -- I think that people are just enjoying clothes, they're enjoying expressing their own personal style and doing it with brands that have values that are aligned to their values, and that's what we're betting on.
Yes. For sure. I'm also in the camp of put on my pajamas as soon as I get home. So skinny jeans, they're comfortable enough these days.
Totally. And it's worth mentioning pajamas because that's been a big category for Old Navy, for all of our brands, as pajamas have become a new fashion item. I think people are paying a lot more attention to what they sleep in. And then denim is coming back. And I think we're pleased with how relevant our denim is for the company. And with the silhouette change, with everyone's bodies changing during the COVID period, whether kids grew or whether people lost or gained weight, all of that is a reason to buy a new pair of jeans with new leg shapes because the leg shapes are changing.
Got it. I was just going to touch on that as well. So given that Old Navy, Gap and Banana were all comping positively in 2012 with the colored denim cycle, it sounds like you're feeling pretty optimistic now that we're heading into another cycle. And just curious how each brand is positioned to benefit and if you're seeing any differences this cycle versus prior cycles.
I mean no one loves a good denim cycle change more than I do. And you're absolutely right, good call on the colored denim phenomenon, which mostly affected Gap, and Gap and Old Navy. But I would tell you this denim cycle, which is about moving from the skinny jean to a range of leg shapes, whether it's the mom jean, the straight jean, the wide leg, the high-rise, there's just a lot of variety and the shift away from the distorted emphasis on skinny, right? So 2 years ago, skinny might have been 70%, 80%, maybe even sometimes close to 90% of the Old Navy business. And certainly for all of our brands, we're seeing now, it's about half and half. Half is that skinny silhouette, half is emerging to be this range of fashion silhouettes and fashion bottoms. And of course, when you change your bottom, guess what you have to do? You change your top.
Absolutely.
Because now your high-rise requires more crop top, or the leg shape requires something a little more tight fitting, or the proportions have changed somehow. So it's good for fashion when we go through a denim cycle.
Absolutely. I wanted to touch on margins in a second, but just a quick one on Banana before that. So comps are down year-over-year and then down versus 2019. And so I just want some color maybe around your level of confidence that the brand can get back to comp positive on a sustained basis. And how do you get there?
Banana entered the COVID crisis in a pretty healthy place, a very nice, profitable, multibillion-dollar business. With end-use that people need, right? I mean look at the pretty top you're wearing, look at the suiting that I'm wearing. These are the things when you have a high-stakes occasion or a high occasion, whether it's a date or a dinner or a wedding or what have you, you want to dress up. And so the end-use is relevant. And I think, look, they were hard hit during COVID, particularly with their city centers, which is where they had a lot of their real estate. And certainly, people are mostly in their sweatpants. That's changing. We're seeing that take hold. We're seeing the accessible luxury positioning be relevant. And then to the power of our scale between the platform and the portfolio, we can all enable Banana's reemergence, right? They -- the tech platform that they sit on is common across our brands. The insights we have on apparel for such a large customer file, Banana benefits from. So those are helping. And then the creative clarity that the new management team is bringing, Beth, I'm really pleased with. And we saw some -- we've seen some cut throughs already. And If you go into a Banana store or on their site today, I think you'll see a difference, and we're excited about the future.
Great, great. And then just in terms of your margin outlook. So as we think about the path to 10% operating margins by 2023 and recognizing that Old Navy and Athleta are probably the principal drivers. What do you need to see happen at Gap and Banana to get there, Gap brand and Banana?
Yes, I'm happy to take that, Beth. I would say -- I'll answer that in 2 ways. First of all, as you say, we are pleased with the healthy margins that we get at both our Old Navy and Athleta brands. And as those grow disproportionately, we do see that being beneficial to the long-term operating margin outlook. That said, many of our initiatives are around restructuring the fixed cost base of the company. A lot of that hits the Gap and Banana Republic brands. And that is intended to actually rebase the profitability of those 2 brands. Sonia and I expect that all of our brands will be healthy, profitable brands that are growing. Maybe at different rates, but growing and probably in different ways. And so our expectation is that the operating margin expansion comes from both of the growth of Athleta and Old Navy with healthy margins, but also the restructuring of Gap and Banana. And I think we've said that as we aspire to our 10% operating margin goal, there's a couple of big levers: the restructuring of our North America fleet, which we are well underway on; the partnering of select international markets, where we believe that the cost of operating in those markets is not worth wholly owned, but certainly serving those customers is important. And so a partner model will be advantaged, and we've said Europe is an example of that. And then also as we look to invest in demand generation, more like some of our peers that run great brands, like a Nike, we are also then looking at restructuring some of our fixed costs through some productivity initiatives to start to get that flywheel going. But all of that will help us bridge to what we're saying is about a 10% operating margin by 2023.
Okay. That's helpful. And then, I guess, given that -- this is on shipping cost headwinds, I think you kind of expect those to be pretty material over the balance of the year, I believe, maybe you said in the neighborhood of 200 basis points. Is there anything you can do in the near-term to reduce some of that pressure? And then in 2022, do you see it more or less going away, a little bit better than '21? What's your kind of outlook?
I'll start with a little bit of thinking on that, Beth. We think that the new normal is this kind of uncertainty. And that's what we're planning for, right? So our whole insight, particularly through last year, is that agility is the advantage. And so whether it's a shipping headwind today or another commodity headwind next year, or the next COVID, what have you, we will be prepared, and we've laid out some of those risks, certainly in our outlook, those are embedded in the outlook for this year that we've taken out the guidance on as well as embedded in our long-range plan, which were -- Q1 puts us ahead on. So we feel like that agility in the shipping costs, as you say, as today's, but tomorrow, it could be something different. Our scale and our strategy, a very simple strategy, will compensate for those and help us navigate the volatility that is the norm now.
Okay. Great. Shifting gears maybe a bit. I wanted to spend some time talking about Gap Home. Recent announcement, you're partnering with Walmart in the home space. So just curious, what drove your decision to partner with Walmart specifically? And then, obviously, you're not even really off the ground and running yet. But any kind of margin implications that we should be thinking about or anything on that front?
When we declared, Beth, that we're all about growing purpose-led lifestyle brands, right, billion-dollar lifestyle brands. The -- an obvious extension of lifestyle from apparel are the ones that we've been talking about, the intimates, for example, or home. And for home, you've seen us make partnership decisions, partner to amplify has been a core tenet of our strategy, whether it was YEEZY or the IMG relationship and now Walmart for home, it's a great partnership. There's a lot of synergies. Walmart is the largest home provider -- home goods provider in the U.S. We're -- we think the scale of Walmart, the cool of Gap and introducing Gap to Walmart's very young customer, they're online customer, which is where we'll be launching Gap Home is Gen Z and millennials. They have an affluence that is nice. And the product elements are Gap through and through. They're modern design, they're -- it's American optimism in the color pallette, very high quality, sustainable, all made for the planet. And the value equation on price is great. So a lot of synergies, we're excited to see what comes. It's coming very soon.
Okay. Great. It looks like we got a question then from the audience, so I'll just read that out to you guys. So as a number of your peers are rationalizing SKU bases, buying deeper and increasing marketing spend behind best sellers, why is it the correct strategy to get -- correct strategic decision to get broader with the launch of intimates, relaunch of GapKids and plus-size expansions across brands?
Yes. I think it's back to the "and". We don't think those are in conflict. We're doing similar things of focusing on the key elements, and you're seeing that in the growth of intimates, the growth of kids and baby, the growth in active, those are all accelerating for us across our brands. So we agree with that question, by the way. We just think we can do that and have a very capital-light, low overhead partner model, leveraging our license -- our Gap license to expand into home. And I don't believe it's a distraction factor. We think that the value of the advertising that Walmart will be putting behind Gap Home will halo onto Gap brand. And so more to come, but we think it's "and".
All right. Maybe just quickly on the real estate front. Your -- after this year, you'll be 75% of the way through your store rationalization efforts. Just curious about when you close a store, what percent of customers migrate online or to another store? And do the retention rates differ Gap North America and Banana Republic brands?
Yes. We're learning so much right now, Beth, in terms of the power of the customer, right? And how do we engage with them, make them loyalists. And some of our fun facts I'm really proud of, we know 188 million customers. 62 million of them are active. The average transaction value has grown substantially in Q1. The frequency is up, and we have a big integrated loyalty launch planned for the fall on the back of adding about 6 million loyalists in our pilot phase for the last 6 months. So the integration and the intimacy with the customer and the scale of the file is a competitive advantage for us, we believe. As we close stores, often our customers are omni customers, they shop online with us, we monitor the omnichannel customer very, very carefully. I think we saw a multiple expansion of our online customers, like a 5x growth of online customers during COVID, which was one of the benefits. So the e-comm strength is one of the big compensating elements to the risk of losing a customer when we shut down a store. That being said, we're very focused on ensuring we have market coverage with our stores. Stores matter. They really matter. And if we're going to have stores, they're going to be in the right locations to ensure the market coverage, and they're going to be proud in terms of the experience and unique. So that's some of the journey. And hopefully, that's helpful.
Yes, certainly is. And so one of the themes of our conference this year is the world post-COVID, which I'm so happy we get to talk about. And I guess, as you think about how that looks and all of the big changes in consumer behavior that we've seen over the past year, what do you expect to be the most lasting and sticky versus what's maybe more temporary?
Yes. Great question. Boy, if we knew the for sure answer to that, I think we'd all be lying on a beach in the Bahamas. But I would say that what we -- certainly, we think the homebody trend is going to continue, this home centricity and the home being the center of much. That's important. Certainly, the digital acceleration, we think, is critical, and we're seeing that in our numbers. We're investing in our technology to support that bet. And then we also think that women's empowerment and sort of the -- that's a very big trend. And we're seeing that with the strength of the Athleta business as an example as well as some of the partners that we're bringing in across all of our brands as a long-term trend. And so these are a few examples. There's maybe 5 or 6 main trends that we're tracking. I don't know, Katrina, if I've missed any that you'd mentioned?
Yes. I mean I'd broaden the sustainability overall. And the fact that the value sort of based culture that is starting to crop up as an importance for brands to have values and to also be good for people and good for the planet, which we think we're well positioned to capitalize on as well. But other than that, I think you captured a lot of the trends, Sonia.
Yes. No, that's a really good point, Katrina. It's something I should have spoken about a little bit more. Look, for 52 years, this company was founded very uniquely by 2 co-founders putting in $21,000 of their respective money, Don and Doris Fisher, to start, right? It's just an example of the platform of equality that the company started on. And we were never afraid to be first. We've always been proud to be first actually in the ESG space, whether it was the first to be certified to pay men and women equally back in 2014 by Stanford. And this is at every job, in every country, at every level. Or we were first this past quarter, ensuring that the 2.5 million workers in our value chain and supply chain were paid electronically, which is a critical stepping stone to financial freedom. So that's about -- around equality in the community side. We're one of the largest employers in the U.S. and we'll be -- we've committed to 20,000 youth, underserved youth from places like the Boys & Girls Club that will be employees in our organization. So that's about supporting our communities. And then certainly, the environment is very big on our minds in terms of sustainability, and we're proud to be often in the top 10% list of companies that are sustainable. And that doesn't rest, right, Beth? That, you have to keep working on that. And with Old Navy's announcement to eliminate plastic bags or Gap's 100% sustainable teen line that they've launched, a couple of examples. Or Athleta's stores that are 100% powered by solar, I mean, we could go on and on. But we are proud to be first in many of these areas, and we'll continue to do so. We think it matters to consumers, and it's our heritage.
Well, thank you for answering my ESG question. It's almost like you know it was coming. So I appreciate a lot of the color there. And if I could, just one more since we're about out of time. It was kind of back to the post-pandemic world and back-to-school. How is the team planning back-to-school different maybe this year than versus pre-COVID?
Look, I think we're -- this is a year with 2 back-to-schools. We had a back-to-school in the spring, and we're going to have a back-to-school in the fall. And the accelerated market share that Gap and Old Navy, in particular, and then add in Athleta Girl, which is being really buoyed by the Simone Biles announcement as she's the face of Athleta Girl. We've got 3 brands that are playing to win for back-to-school from a place of strength. And so we're buying into that opportunity. We think we're well positioned. And whether it's here as well as around the world for Gap, frankly, there's a lot of affinity for these brands for back-to-school. It's a major family event. And this year, more poignant than ever for parents to send their kids back with confidence and with style, so that they can have a year of productive learning after the year that we just had. So we're planning to connect with emotionally what the families are needing and also to have all the product that is required and that kids want.
All right. Great. I think that will pretty much wrap it up. Thank you, again, both for joining us. And hopefully, we can see you again.
Thanks, Beth, for hosting us today.
Sure thing.
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