Gap says tariffs will cost hundreds of millions but doesn't expect 'meaningful' price increases

Gap Inc. reported better-than-expected Q1 earnings with EPS of $0.51 on revenue of $3.46 billion, but shares fell over 15% in after-hours trading due to concerns about potential tariff impacts. The company estimates new tariffs could cost $100 million to $150 million annually despite mitigation efforts, primarily affecting the back half of the year; full-year sales are expected to grow 1-2%. While Old Navy and Gap brands showed positive sales growth, Banana Republic and Athleta continue to face challenges.

Analysis

Gap Inc. reported fiscal first-quarter earnings that surpassed Wall Street expectations, with earnings per share of 51 cents against a 45-cent consensus and revenue of $3.46 billion versus $3.42 billion anticipated. This represents a net income increase to $193 million from $158 million year-over-year and a sales rise of approximately 2%. Despite these positive results, the company's shares declined over 15% in after-hours trading, reflecting a moderately negative sentiment (ticker sentiment -0.7) primarily driven by concerns over new import tariffs. Management estimates these tariffs could inflict a $100 million to $150 million impact after mitigation efforts, which include diversifying its supply chain and reducing sourcing from China to less than 3% by year-end from under 10% previously; without mitigation, the cost could reach $250 million to $300 million. CEO Richard Dickson stated the company does not anticipate meaningful price increases for consumers due to these tariffs, relying on brand strength. However, the potential for a 46% reciprocal tariff on imports from Vietnam, a major sourcing country (27% in FY24), poses a significant unquantified risk for the latter half of the year. Full-year sales growth guidance of 1-2% aligns with expectations, but the forecast for gross margin at 41.8% is weaker than the anticipated 42.5%, and second-quarter sales are projected to be flat, slightly below consensus growth of 0.2%. Brand performance was bifurcated: Old Navy and the core Gap brand delivered strong comparable sales growth of 3% and 5% respectively, exceeding forecasts and indicating progress in turnaround initiatives for the Gap brand. Conversely, Banana Republic sales fell 3% with flat comparables, missing expectations, and Athleta sales dropped 6% with an 8% comparable sales decline, with improvements for Athleta expected to 'take time'.

Key Decisions for Investors

• Investors should weigh the strong Q1 operational performance and successful turnaround signs at Old Navy and Gap brands against significant near-term headwinds from potential tariffs and a weaker gross margin outlook.
• Closely monitor the company's progress in mitigating tariff impacts, particularly any developments regarding tariffs on goods from Vietnam, and assess the actual impact on margins and profitability in the latter half of the year.
• Consider the divergent performance across Gap's brand portfolio; sustained improvement in the core Old Navy and Gap brands could offer upside, but persistent weakness in Banana Republic and Athleta remains a drag on overall growth and profitability.
• Evaluate whether the substantial post-earnings share price decline adequately incorporates the heightened tariff risks and softer margin guidance, or if current levels present a strategic entry point contingent on successful long-term strategic execution and a more favorable trade environment.