Gap drops after analyst points to sales weakness at namesake brand

Shares of Gap Inc (GPS) dropped in pre-market trading after an analyst at JPMorgan downgraded shares to Underweight, pointing to sales weakness at the apparel seller's flagship Gap stores as well as profit margin pressures. MOUNTING MARGIN PRESSURES: JPMorgan analyst Matthew Boss downgraded Gap, which owns the Gap, Old Navy and Banana Republic brands, to Underweight from Neutral and lowered his price target for the shares to $24 from $30. In a research note to investors, Boss lowered his second half earnings per share estimate to $1.33, below the Street at $1.39, which reflects continued sales weakness at the core Gap brand and greater gross margin pressure in the second half of 2018. Boss also lowered his fiscal 2019 EPS estimate to $2.38, below the Street at $2.70. Boss said that the timeframe for sequential same-store sales improvement at the Gap brand and the return to "momentum," which was last seen in the second half of 2017, is now "less certain" as the brand deals with operational issues and assortment imbalance, and told investors that the new brand president is unlikely to have a material impact until the first half of 2019. Boss also pointed out a "trifecta" of factors that are expected to drive continued gross margin pressure in the near-to-medium term, including a more promotional Gap brand in Q4; freight inflation, which management has pointed out as an incremental headwind in FY19 vs. FY18; and tariffs, with Boss noting that direct sourcing exposure to China stands at 22% currently. OLD NAVY STILL A 'BRIGHT SPOT': Despite the Gap brand's woes, Boss acknowledged that Old Navy remains a "bright spot" and remains on "solid" fundamental footing given the combination of quality product, store experience and "effective" marketing. However, the analyst said that while Old Navy is "best of breed," with nominal GDP at 5%, unemployment sub-4% and wage growth benefiting the U.S. consumer, core Gap's inability to demonstrate SSS improvement raises forward concerns if macro tailwinds moderate in 2019. WHAT'S NOTABLE: In June, Gap named Neil Fiske as president and CEO of the Gap brand. Fiske was previously CEO of Billabong International, where he helped the brand return to a position of multiyear share growth. PRICE ACTION: In pre-market trading, shares of Gap are down about 5%.