By Elizabeth Holmes
Gap Inc. warned that raw-materials costs are rising faster than expected—and faster than it can raise prices—creating a squeeze that will eat into the company's profit this year.
The country's largest apparel retailer by sales, which is struggling to turn around its namesake brand's long-suffering North American operations, delivered the sobering outlook while reporting a 23% drop in profit for its fiscal first quarter. Shares tumbled 15% after hours.
Gap said costs per item will be up 20% in the second half of the year, an increase it won't be able to pass on to shoppers in full. The cost pressure is highest at its Old Navy and outlet businesses.
"I'm obviously disappointed at the numbers we are giving today," Chief Executive Glenn Murphy said on a conference call to discuss the results.
Apparel retailers across the board are facing big gains in the price of materials like cotton and rising labor costs in manufacturing centers like China, but the seriousness of Gap's disclosures caught investors by surprise. Shares dropped to $19.74 after finishing slightly higher at $23.29 in 4 p.m. composite trading on the New York Stock Exchange.
The company, which has had to discount aggressively to move its clothes, also reported swelling inventories, reducing its leverage to raise prices. "We have every intention to be less promotional," Mr. Murphy said Thursday. "That's our goal."
Gap reported profit of $233 million, or 40 cents a share, for the quarter ended April 30, down from $302 million, or 45 cents a share, a year earlier. Sales fell 1% to $3.3 billion, while sales at stores open at least a year, a key measure of a retailer's health, fell 3%.
The company's gross margin narrowed to 39.6% from 42.1%.
For the full year, Gap now sees earnings of $1.40 to $1.50 a share, down from the $1.88 to $1.93 it forecast in February.
By contrast, Limited Brands Inc., which owns Victoria's Secret and Bath & Body Works, said in a conference call Thursday that rising cost pressures this fall wouldn't cause its gross margin to narrow.
Limited has kept a tight rein on discounts and inventories. Late Wednesday, it reported a 47% jump in fiscal-first-quarter profit and raised its outlook for the year.
Gap's inventory per store grew much faster than sales, up nearly 10% at the end of April, which it attributed in part to decreased business in Japan after the natural disaster there.It expects inventory per store to be up in the mid-teens at the end of July.
One of the company's biggest challenges is turning around the domestic division of its namesake brand, where inconsistent product has been a drag on sales. Earlier this month, the company removed its top designer, Patrick Robinson. In February, the company replaced the North American brand president.
Gap has focused on expanding abroad to offset weakness in North America, most recently announcing agreements with franchise partners to expand to Serbia and the Ukraine. Over the past five years, Gap's franchise network has expanded from two countries to 24, with locations throughout the Asian-Pacific region, Europe, Latin America and the Middle East.
