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Tickers in this Article: GPS, ANF, AEO, ARO
Gap Inc. (NYSE:GPS) saw slumping sales in a very weak retail environment, but was able to boost profits through savvy cost cutting. Strong management helped the clothing chain raise its bottom line 40% even as more customers shrugged off its stores. This is a poor economy for retail, but Gap's management showed the best way to cope and ended up with an impressive performance.

Who Needs Revenue?
Gap reported first quarter income of $249 million (34 cents per share) up sharply from the $178 million (22 cents per share) reported a year earlier. The earnings per share came an impressive 4 cents ahead of consensus analyst expectation and is a true bright spot for a company that has been suffering over the past few years.

The profit rise came even as revenue slipped 5% to $3.38 billion from $3.55 billion a year earlier and missed analyst estimates of $3.42 billion. With the continuing fall in sales, management rolled up its sleeves and helped costs fall even faster. The company saw a reduction of its cost of goods sold and occupancy expenses by 6.9% for the quarter to $2.04 billion from $2.19 billion a year ago. Gap also reduced operating expenses by 8.75% to $959 million from $1.05 billion. The earnings per share were also boosted by a sharp decline in shares outstanding. Weighted average diluted shares outstanding dropped to 736 million from 819 million in the previous year. Gap hired CEO Glenn Murphy last July, and he has done a great job for the company by improving its inventory management and helping its stores avoid large markdowns on product. Overall management did an impressive job of getting profits up despite continuing weakness in the economy and its stores, but those concerns still loom large. (To learn more, check out Measuring Company Efficiency.)

Continuing Brand Weakness
The company which runs its namesake stores, along with subsidiaries Old Navy and Banana Republic has seen its same store sales decrease for 15 consecutive quarters. That is staggering and goes beyond the current widespread weakness in retail. Gap has been suffering for the last four years and with a pronounced problem across all of retail, the situation is not looking any better. Same store sales for dropped 11% year over year, in what actually turned out to be the company's worst drop over this four year decline.

All this comes as recent signs from some retailers haven't been all that bad. Clothing retailers Abercrombie & Fitch (NYSE:ANF), American Eagle (NYSE:AEO) and Aeropostale (NYSE:ARO) all showed positive same store sales growth in April, while Gap's stores slumped. Somewhat surprisingly, Old Navy, Gap's discount brand, has suffered the worst with an 18% decline in same store sales for the quarter.

The company is a strong presence in the retail environment with 3,177 stores worldwide, but in a sign of smart thinking, Murphy is looking to reduce that to 3,000 by the year end. Murphy has been effective as CEO, and I look forward to him culling weak stores from the company. However, the overriding issue remains that Gap's brand has been suffering immensely. Until things improve for the economy and retail as a whole, there will not be improvement on Gap's top line, where it needs it most.

The Bottom Line
Gap's strong management led it to have an impressive rise in quarterly earnings growth, despite 15 consecutive quarters of decreasing same store sales. CEO Glenn Murphy has done a good job improving the company's efficiency, but Gap won't look like a good investment until it sees improvements in sales. A company cannot win if sales go down forever, and that is what Gap has been experiencing. I would stay away from the stock until the retail environment improves.

To predict sales growth, read Great Expectations: Forecasting Sales Growth.

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