Gap finally sees positive numbers

SAN FRANCISCO -- After 2 1/2 years of bad fashion statements and financial humiliation, Gap Inc. doesn't look so scruffy anymore.

The San Francisco-based company's 3,158 stores have been restocked with more basic clothing designed to appeal to mainstream tastes and its catchy ads appear to be luring back once-alienated customers.

Those factors translated into a surprisingly strong October that marked the end of a 29-month sales slide at Gap. The improvement raised hopes that the long-slumping retailer is poised to regain its former flair.

But despite the encouraging signs, no one -- not even Gap itself -- is ready to say the company's comeback is complete. It still must prove it can string together several successive months of sales growth, and to do that, Gap will have to overcome a shaky economy that's keeping consumers on edge.

"Coming back is always hard, but coming back in an environment like this is even more difficult," said industry analyst Holly Gustafson of Legg Mason.

The challenge facing Gap is further complicated by the labor situation in West Coast ports, where much of the company's merchandise enters the country. A 10-day shutdown of the ports earlier this fall meant some of Gap's holiday shipments will arrive at stores a month later than anticipated. Gap expects that to lower its profits by as much as $42 million during the holiday season.

Unexpected windfall

That setback still won't wipe out an unexpected windfall the company generated from a busy October at its three chains -- Gap, Old Navy and Banana Republic.

The company's sales at stores open at least a year rose 11 percent in October, halting a slide that began in May 2000. These sales, known as same-store sales, are a key measure of a retailer's health.

The October surge fattened Gap's profits far beyond investors' expectations. The retailer reported Thursday it earned 15 cents per share during the third quarter, a penny more than analysts expected, and far above the 6 cents per share Wall Street had forecast just weeks ago.

"This is a very positive step in the right direction, but we are still cautious about the company's outlook," said industry analyst Adrienne Tennant of Wedbush Morgan Securities.

The October rebound represents a measure of redemption for Gap's longtime leader Millard "Mickey" Drexler, who retired in late September. Long regarded as one of retailing's smartest executives, Drexler's reputation suffered as he presided over Gap's downfall.

During the final months of his tenure, Drexler vowed to get Gap back on track by returning to the staples that made the company one of the hottest retailers of the 1990s.

"He made some powerful changes before he left," said Wells Fargo Securities analyst Jennifer Black. "Mickey has laid the groundwork for a turnaround and deserves a lot of credit."

It will be up to Gap's new CEO, Paul Pressler, to keep sales growing. Pressler joined Gap after running Walt Disney Co.'s theme parks.

Wall Street is trying to figure out whether October represented a return to form for Gap or an aberration driven largely by bargain-hunting consumers who flocked to its Old Navy stores.

The discount chain appeared to touch a nerve with a television commercial revolving around actress Morgan Fairchild and the theme song of the old TV series, "Green Acres."

At Old Navy, same-store sales rose 24 percent in October compared to a 6 percent gain at Banana Republic and a 1 percent increase at the U.S. stores of the flagship Gap division.

"Can that momentum keep building or did people just take advantage of some low prices in October and things will start to fizzle again in the holiday season?" Gustafson wondered.

Gustafson and other analysts also are worried that a sluggish holiday season will force retailers to slash prices to attract business.

Optimists see plenty of upside for Gap. The company's return to more basic fashions even bodes well in a weak economy because those clothes have always sold well in uncertain times, said UBS Warburg analyst Richard Jaffe.

Another encouraging sign: October's same-store sales were higher although customer traffic was down from a year ago. The traffic decreases ranged from 3 percent at Old Navy to 8 percent at the Gap chain.

These figures suggest that shoppers who came to the stores liked what they saw so much that Gap didn't have to discount merchandise as deeply as last year to generate sales. This phenomenon produced higher sales per customer and boosted the company's profit margins.

"What we saw in October could be just the tip of the iceberg," said Black, a one-time harsh Gap critic who has been converted into one of the company's biggest boosters. She expects Gap's stock to soar to $30 as the company continues to woo back shoppers.

Gap's shares are currently trading in the $13 range, up from a 52-week low of $8.35 but still sharply bellow the $36.75 the stock traded at in May 2000, when sales began their slide.

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