Strategy

Gap’s Credit Rating Downgraded to Junk

Fitch Ratings expresses doubts about Gap's cost-cutting strategy, saying earnings will fall this year even with $100 million in expense reduction.
Katie Kuehner-HebertMay 11, 2016

Fitch Ratings on Wednesday downgraded The Gap Inc. to junk status, expressing doubts about the retailer’s efforts to protect earnings through cost-cutting.

The downgrade takes Gap’s debt down one notch to BB+ from BBB-, bringing it below investment grade.

Fitch cited its “reduced confidence in stabilization of sales, expectations of continued gross margin volatility, and belief that Gap will need to continue using real estate actions and large-scale cost reduction programs to protect EBITDA in the face of sales declines.”

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The rating agency expects Gap’s EBITDA to decline to the $2 billion range in 2016 versus $2.3 billion in 2015 and a peak of $2.7 billion in 2014.

“While traffic declines are an issue across the mall space, Gap’s outsized declines are an indication that customer loyalty is waning as product continues to disappoint,” Fitch said in a news release.

The company last week reported April net sales of $1.12 billion for the four weeks ended April 30, compared with $1.21 billion for the year-ago period. For the first quarter of fiscal 2016, net sales were $3.44 billion compared with $3.66 billion for the first quarter last year.

Gap also announced it was identifying opportunities to streamline its operating model “to be more efficient and flexible, while more fully exploiting its scale advantage” and will evaluate its international real estate assets, primarily Old Navy and Banana Republic stores, to offset weak sales.

Fitch said it has generally viewed Gap’s restructuring moves positively, but the company’s “continued reliance on transformational cost management programs to protect EBITDA as sales decline is a negative.”

“Fitch expects 2016 EBITDA to decline approximately 15% to $2 billion even with a projected $100 million of net expense reduction,” the agency said.

As The Wall Street Journal reports, “Gap is being squeezed by fast-fashion retailers such as H&M operator Hennes & Mauritz AB and Zara owner Inditex SA, which push low-price items and shift their selections quickly. To combat the sales slump, Gap CEO Art Peck has brought in new executives and promised to source goods more quickly.”