Gap Downgraded to Junk at Fitch

Gap Inc. (NYSE: GPS) has been downgraded to junk ratings at Fitch Ratings. The news comes on the heels of multiple analyst downgrades or price target cuts after this week’s disastrous earnings report.

Fitch downgraded the Gap’s Long-Term Issuer Default Rating to BB+ from BBB-. Had the rating remained at BBB-, it would have remained investment grade. The only good news here is that Gap’s Rating Outlook is Stable, implying that more downgrade risks are not immediate.

Before investors panic just on a credit rating downgrade, they should note that Fitch’s rating continues to reflect positive aspects of Gap’s credit story. The ratings agency said that Gap has capital discipline, positive free cash flow, scale and investments in Omni channel capabilities. Fitch said in its downgrade report:

The downgrade reflects Fitch’s 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. Fitch expects 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, with leverage expected to remain in the mid-3x range.

There is a weak outlook that just cannot be ignored here. Gap’s comparable store sales continue to suffer. A reading of −5% in first-quarter comparable sales figure comes after a reading of −7% in its fourth quarter.

Gap should be able to win from significantly easier comparisons and benefit from sourcing and merchandising changes made back in 2015. Instead it sees material decline continuing. Overall traffic declines are an issue across the mall space, but Gap has problems on top of all the macro issues.

Gap’s April net sales were $1.12 billion for the four-week period ended April 30, 2016, versus $1.21 billion a year earlier. Here is what Gap CEO Art Peck said of its own quarterly sales trends:

Our industry is evolving and we must transform at a faster pace, while focusing our energy on what matters most to our customers. We are committed to better positioning the business to recapture market share in North America and to capitalizing on strategic international regions where there is a strong runway for growth.

Gap shares suffered handily on Tuesday, falling to $19.30, after closing at $21.81 on Monday. That’s an 11.5% drop. Things weren’t looking any better on Wednesday with a drop of 3.1% to $18.70. Gap’s new 52-week range, after hitting a multiyear low on the same day, is $18.70 to $39.59.

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