-- U.S. specialty apparel retailer Gap Inc. reported strong
operating performance in recent quarters, with meaningfully increased operating
margins and consistent, positive same store sales.
-- We are revising our outlook on Gap to positive from stable.
-- At the same time, we are affirming our ratings on Gap, including the
'BB+' corporate credit rating.
-- The positive outlook reflects that we could raise the ratings if Gap
continues its positive operating performance trend, with expanding margins and
positive same store sales, warranting a change in our assessment of Gap's
business risk profile.
On Nov. 20, 2012, Standard & Poor's Ratings Services revised its outlook on
San Francisco-based specialty apparel retailer The Gap Inc. (Gap) to positive
from stable. At the same time, we affirmed our ratings, including the 'BB+'
corporate credit rating on the company.
The rating on Gap reflects Standard & Poor's Ratings Services' assessment of
the company's "fair" business risk profile and "intermediate" financial risk
profile. Gap's business risk profile reflects our view of Gap's good market
position in casual apparel, strong brand name, and geographic diversity. We
also believe Gap has demonstrated some improvement in product merchandising
and regaining customer traffic in recent quarters, as same-store sales turned
positive in the first three quarters of 2012. Our analysis is tempered by the
intensely competitive nature of apparel retailing. We also believe that
specialty apparel trends will continue to be difficult to predict, and that
Gap will remain vulnerable to changes in fashion. As a result, the company's
performance could be uneven because of the timing of consumer buying and
changing fashion trends.
We expect margins to expand in the remainder of 2012 and in the first half of
2013, as commodity pressure eases and sales continue to improve. Following
significant margin deterioration in fiscal 2011, primarily because of higher
commodity prices (especially for cotton), margins have started to recover in
recent quarters. As of Oct. 27, 2012, EBITDA margin for the last 12 months was
17.2%, comparable with 17.5% a year ago.
Our forecast for the company's operating performance is as follows:
-- Revenue rises modestly, reflecting flat to low-single-digit positive
comparable sales and continuing unit growth internationally;
-- EBITDA margins improve to about 18.8% at year-end 2012 and then to
about 20% in fiscal 2013; and
-- The company continues to generate solid free operating cash flows
(FOCF) in the $900 million area in fiscal 2012 and we believe it will fund its
shareholder initiatives primarily with FOCF.
We view Gap's financial risk profile as intermediate, reflecting its
consistent good cash flow generation and credit measures that are in line with
an intermediate financial risk profile. As of Oct. 27, 2012, total debt to
EBITDA was 2.1x and funds from operations (FFO) to total debt was 41%. We
believe Gap' short average store lease tenor makes our adjusted credit ratios
appear somewhat stronger than they would be if longer lease tenors were used.
Still, we believe that credit metrics will improve moderately in the remainder
of 2012 and in 2013, and remain in line with an intermediate financial risk
Gap's liquidity profile is "strong," in our view. The company should be able
to withstand substantially adverse market circumstances over the next 24
months while maintaining sufficient liquidity to meet its obligations. Our
assessment of Gap's liquidity profile incorporates the following expectations,
assumptions, and factors:
-- We expect liquidity sources to exceed uses by 1.5x or more over the
next 12 months. Even over the next 24 months, we believe the measure will
remain above 1.0x.
-- We also expect net sources to be positive, even with a 30% drop in
-- Covenant compliance would also survive a 30% drop in EBITDA.
-- The company appears to have well-established, solid relationships with
its banks and a generally high standing in credit markets.
As of Oct. 27, 2012, Gap had $1.7 billion of cash and ample availability under
its $500 million revolving credit facility due 2016. The company's share
repurchase activities have moderated in fiscal 2012, with year-to-date
repurchases of $467 million, significantly less than the $2.1 billion in
fiscal 2011. It generated over $800 million in FOCF in fiscal 2011 and we
believe that free cash flow generation could rise above $900 million in fiscal
2012. Cash on hand, cash flow, and availability under the revolver provide
adequate liquidity sources to fund the company's capital spending, dividends,
and share repurchases.
Gap's revolving credit facility contains financial covenants (leverage and
fixed-charge ratios). It was in compliance with these covenants as of Oct. 27,
2012, and we expect covenant cushion to remain adequate.
For the complete recovery analysis, see Standard & Poor's
7041717&rev_id=6&sid=982065&sind=A&", published Dec. 15, 2011, on
The outlook is positive. We could raise the ratings if Gap continues its
positive operating performance trend, with expanding margins and positive same
store sales, including the fourth-quarter holiday season. This performance
could warrant a change in our assessment of Gap's business risk profile.
We could revise the outlook to stable if the company is unable to maintain
positive same store sales and margin expansion in the next several quarters.
We could also revise the outlook to stable if the company adopts more
aggressive financial policies--for example, if it increases debt by about $1.7
billion to buy back shares.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings Affirmed; Outlook Action
The Gap Inc.
Corporate Credit Rating BB+/Positive/-- BB+/Stable/--
Ratings Affirmed; Recovery Rating Unchanged
The Gap Inc.
Senior Unsecured BB+
Recovery Rating 3
Complete ratings information is available to subscribers of RatingsDirect on
the Global Credit Portal at www.globalcreditportal.com. All ratings affected
by this rating action can be found on Standard & Poor's public Web site at
www.standardandpoors.com. Use the Ratings search box located in the left