Shares of Gap Inc. GPS were up 7.7% Thursday in after-hours trading as the company raised its fiscal 2017 outlook following the better-than-expected third-quarter results. This was the company’s third straight quarter of positive earnings surprise while it recorded sixth consecutive sales beat. Also, comparable store sales (comps) reflected strength for the fourth quarter owing to continued momentum at key areas of the company’s business.

However, foreign currency adversely impacted this Zacks Rank #4 (Sell) company’s bottom line, which declined on a year-over-year basis.

Nonetheless, the stock gained 21.3% in the last three months, outperforming the industry’s growth of 14.2%.

Q3 Highlights
   
Gap’s adjusted earnings of 58 cents per share in the fiscal third quarter surpassed the Zacks Consensus Estimate of 55 cents. However, the bottom line declined 3.3% from 60 cents earned in the year-ago period. Currency dented earnings per share growth by about 3 percentage points. Also, on a GAAP basis, earnings came in at 58 cents compared with 51 cents in the prior-year period.

Gap, Inc. (The) Price, Consensus and EPS Surprise

Gap, Inc. (The) Price, Consensus and EPS Surprise | Gap, Inc. (The) Quote

Net sales grew 1.1% to $3,838 million and also fared better than the Zacks Consensus Estimate of $3,774 million. The upside was backed by comps growth of 3%, as against a 1% decline in the year-ago period.

Meanwhile, comps continued to gain from robust Old Navy performance that was fueled by improved traffic. Also, the company’s namesake brand witnessed comps growth, which aided results. These were partly offset by persistent softness across Banana Republic. Looking at numbers, Old Navy and Gap comps grew 4% and 1%, respectively, as against Banana Republic’s comps decline of 1%.

Margins

Gross profit rose 2.1% to $1,525 million with the gross margin expanding 40 basis points (bps) to 39.7%. Adjusted gross margin grew 60 bps, mainly owing to rent and occupancy leverage of 60 bps backed by comps growth. The figure was offset by flat merchandise margins.

Operating income fell 2.8% to $378 million with operating margin contracting 40 bps to 9.8%. Also, the adjusted operating margin contracted 120 bps due to higher adjusted operating expenses. These expenses stemmed from greater marketing as well as payroll costs, along with investments in digital and customer service initiatives.

Financials

Gap ended the quarter with cash and cash equivalents of $1,353 million, long-term debt of $1,248 million, and total stockholders’ equity of $3,024 million.

During the nine months of the current year, the company generated cash flow from operations of $600 million and incurred capital expenditures of $463 million. Gap had free cash flow of $197 million as of Oct 28, 2017.

For fiscal 2017, management continues to project capital expenditure of roughly $625 million, excluding the planned $175 million spending associated with reconstructing the Fishkill, New York distribution center campus and related supply chain costs.

Coming to Gap’s shareholder-friendly moves, the company paid a dividend of 23 cents per share in the reported quarter and bought back 3.8 million shares for approximately $100 million. Year to date, the company paid $272 million as dividend. Additionally, the company declared fourth-quarter dividend of 23 cents per share on Nov 9. Going forward, management plans to make buybacks worth roughly $100 million in the impending quarter.

Store Updates

In the third quarter, Gap introduced 50 stores while it shuttered 53 stores. Of these 50 stores, 41 were company-operated and nine were franchise. Similarly, the stores that were closed included 27 company-operated and 26 franchise stores. Consequently, the company ended the quarter with 3,639 outlets in 46 countries, of which, 3,193 were company-operated and 446 were franchise.

Gap now anticipates closures of nearly 30 company-operated stores, net of openings as well as repositions in fiscal 2017.

Outlook

Management remains impressed with the success against its balanced growth strategy that was announced in September. In this regard, Gap remains focused on enhancing product categories, boosting its web and mobile offerings and enhancing its footprint in the value and active space.

Backed by these initiatives and a solid performance in the nine months of fiscal 2017, management raised its outlook for the year.

Currently, Gap envisions adjusted earnings for the fiscal year in the range of $2.08-$2.12 per share compared with $2.02-$2.10, projected earlier. The Zacks Consensus Estimate is pegged at $2.06, which is likely to witness an upward revision following the upbeat outlook. Further, comps are anticipated to be up low-single-digits versus earlier projection of flat to marginal improvement.

For the next quarter, management expects SG&A expenses to grow at the same pace as it has increased year to date.

Looking for Solid Picks, Check These

Investors can count upon some better-ranked stocks in the same industry like Zumiez Inc. ZUMZ, Boot Barn Holdings, Inc. BOOT and The Children's Place, Inc.PLCE, each carrying a Zacks Rank #2 (Buy).You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Zumiez, with a long-term earnings growth rate of 18% has pulled off an average positive earnings surprise of 27.1% in the last four quarters.

Boot Barn Holdings, with a long-term earnings growth rate of 15.7% has delivered positive earnings surprise of 100% in the previous quarter.

Children's Place, with a long-term earnings growth rate of 9% has come up with an average positive earnings surprise of 14% in the trailing four quarters.