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Gap Presents Very Compelling Risk/Reward Opportunity

Encouraging developments in the retailer’s third quarter reinforce our view that the firm’s turnaround is on track, writes Morningstar’s Bridget Weishaar.

Although third-quarter comparable sales were down 2% and 2015 adjusted earnings per share guidance was lowered to $2.38 to $2.42 (from $2.75 to $2.80), management reiterated its progress in its turnaround plan and we saw some positive data points. We still believe there is a place for the

We stand by our belief that long lead times have prevented new design and supply chain initiatives from showing results until the first quarter of 2016. That being said, there were some encouraging developments in the third quarter. First, management has done a good job of clearing excess inventory and is entering the holiday season with inventory per store down 4%. This is particularly impressive given high inventory levels at competitors. Second, the Gap brand's negative 4% comp was a slight improvement from the negative 5% in the prior year, and negative 6% in the prior quarter, so trends are not worsening. Third, the company is managing expenses carefully and we expect limited marketing spend and inventory investments, until new product has proven successful. Finally, Old Navy product acceptance continues to be strong across all categories, which we think reflects its responsive supply chain.

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