Let’s be clear, Mr. Murphy has done a fabulous job at The Gap (GPS – $21.63). 

But, let’s not get too excited about the sudden comp store sales turnaround at Old Navy since the chain has been lapping last year’s strategic merchandising flop and has benefited from a higher marketing spend. 

In addition, we see little hope for the core chain after the dismal re-launch of denim and the fact that we believe Old Navy is currently cannibalizing its sales.  All the incremental marketing spend did in Q4 2009 for The Gap was to stop the bleeding. 

The core chain will continue to lose market share as its bloated store size (well suited for the 1980’s/1990’s) and “one size fits all” strategy is consistently outflanked by its more nimble specialty apparel peers.

It’s probably fair to say that GPS entered FY 2007 with a low bar based upon the fact that the company was one of the few retailers that reported negative comp store sales in FY 2005/2006. 

Yet, despite the low bar coming into FY 2007 and incremental +33% marketing spend in Q4 2009, the company’s current 3-year comp store sales run rates leaves a lot to be desired relative to its peers.

Mr. Murphy mentioned on yesterday’s conference call that The Gap’s turnaround is likely to be a longer “journey” than he originally envisioned.  This journey is turning into a nightmare for him and we see nothing over the horizon that will stem the tide at the core chain.

3-Year Comp Store Sales Run Rates

Per J. Crew’s (JCG – $40.45) Q3 2009 conference call:

“To our branded partnership business such as Alden hand crafted men’s shoes from a family-owned New England factory, Belstaff from an English company dating back to 1924, and Quoddy hand-made moccasins from Perry, Maine to name just a few.” 

“We are acting as editors, finding and searching for the best quality, timeless products in the world and giving our customers access to them.  We feel we are creating a very unique approach and our customers are clearly getting it.” 

We applaud JCG for romancing its offering with harder-to-find items such as Selima sunglasses, Globe-Trotter luggage, and Timex watches.  These items are particularly appealing because they are categories not already offered at J. Crew. 

But we are scratching our heads as to why JCG thinks they need to offer men’s Levi’s 501 denim (launched February 2010).  Today, higher-volume JCG stores offer Levi’s 501 denim in 5 “exclusive” washes that store associates admit are “close to washes found elsewhere.” 

More astonishing is that J. Crew slapped a $98 price-tag on Levi’s styles that are priced $48 – $58 for similar styles/washes at department stores.  Even Urban Outfitters (URBN – $31.71), a chain that is infamous for its mark-ups doesn’t charge more than $54 for its assortment of Levi’s 501 denim. 

We guess that’s what Mr. Drexler means by its “unique approach!”

What’s likely going on here is that J. Crew needs to charge $98 to prevent cannibalization of its own private label $98 men’s denim offering.  But we are certain that the J. Crew customer is too savvy to pay 2X for a ubiquitous brand such as Levi’s.

J. Crew expanded its branded partnership business to include men’s Levi’s denim this month

Yesterday, Nordstrom (JWN – $36.19) reported $21 million higher Credit SG&A Expense than the high-end of management’s materially higher guidance range provided just 3 months ago.

JWN management has consistently suggested that there is a strong correlation between Write-offs/Bad Debt Expense and the unemployment rate.  Yet, the unemployment rate declined from just over 10.0% 3 months ago to 9.7% today.  If a strong correlation, why did the company report materially higher Bad Debt Expense in Q4 2009 than the company’s projection just 3 months earlier?

Conversely, this morning Target (TGT – $50.06) made the following statement on their quarterly earnings conference call.  This statement provides investors comfort that TGT management has its expectations of Bad Debt Expense/Write-offs well under control:

“We have made a lot of predictions a year ago.  Some of them we ended up exceeding the predictions we laid out.  The forward looking statements we laid out for our card segment by and large turned out to be spot on.  We predicted $300 million plus or minus in write-offs in each of the first two quarters.  That’s exactly what happened.  We predicted a little less than that in Q3.  Exactly what happened.  Due to a little bit of an echo of expected write-offs from a terms change in May, we predicted write-offs to tick up a bit in Q4.  That’s again exactly what happened.  Looking forward, Q1 write-offs will look a lot like Q4 write-offs, and I expect Q2, Q3, Q4 to be lower as the portfolio shrinks.” 

The fact is that JWN and TGT both own their credit portfolios.  They’re the last of a dying breed as many retailers sold their credit portfolios over the past decade.  But, that’s where the similarities end.  TGT management clearly has a handle on how to forecast its write-offs while JWN management apparently does not have the expertise on board to effectively predict the credit segment’s write-offs.

In addition, TGT and JWN are utilizing their credit operations differently.  TGT has been scaling-back its credit exposure over the past 18 months (seems reasonable) while JWN has made a conscious decision to grow its credit portfolio in the face of the worst consumer downturn since the Great Depression.  Of course, it turns out that the company that appears to be foolishly growing its credit exposure is the same company that struggles to forecast its credit losses.  Does this sound familiar (Mortgage Bubble anyone)?  

How can investors get comfortable with a management team that is clearly using credit availability to artificially drive sales volume and yet cannot seem to get its arms around its bad debt write-off exposure?

Oh, did we mention that JWN lost $82 million on its credit operation in FY 2009 while TGT made $298 million.  Go figure.

See the links for credit segments scorecards for both JWN and TGT.

You’ve read the magazines and listened to the muddied and confusing predictions from fashion forecasters.  But what follows are the new Spring trends that are actually selling at mall-based retailers today.

1. Jeggings is what you get when leggings are designed to look like jeans.  Retailers from Wet Seal to Nordstrom can’t keep the trendy lower-priced denim option on the shelves this season.

2. Utilitarian chic Cargo Jackets and Slim Cargo Pants are easy and relatively classic updates that take women from work to weekend.  Teen retailers and missy retailers alike have jumped on this trend for Spring.

3. Always a classic, blue Chambray is in the spotlight this Spring driven by the Americana trend.  The appealing and soft blue fabrication looks great on most every complexion.  Usually a “no-no,” matching denim-on-denim is actually encouraged this Spring!

4. Replacing lumberjack plaids, women and teens are ready to add a little femininity to menswear separates (basic cardigans, denim, vests) that have been driving sales over the past year.  Enter mini “ditsy” floral print tanks, blouses, skirts, and dresses.  Floral layering pieces are easy updates that appeal to both conservative prepsters and bohemians.

5. Mini has hit mainstream.  Hemlines are up and anything slightly above the knee and higher is a go.  Often worn over leggings or tights (or even denim!), women aged 9 to 49 are wearing mini-skirts and short shirt dresses this Spring.

It appears that the sell-side analyst community was a bit surprised today by J.C. Penney’s (JCP – $27.53) comp store sales expectations for Q1 2010.  Flattish comp store sales in Q1 2010 would imply a materially improved 2-year comp store sales run rate for JCP (see chart below).

What’s interesting is that JCP’s peers generally reported materially stronger 2-year comp store sales run rates in Q3/Q4 2009, unlike the continued deceleration at JCP during the back half of FY 2009. 

Therefore, while JCP’s top-line is headed in the right direction, it’s difficult for us to get too excited.  JCP’s 2-year comp store sales run rates began to decline sooner and lasted longer than Macy’s (M – $18.52).  Also, the company did not want to sign-up for any material improvement in profitability in FY 2010 today (excluding lower Pension Expense).

At the end of the day, long overdue top-line improvement… yet, no profitability improvement is being forecasted by management.  We’re not sure where this bridge leads, but it’s not leading us to believe historical rates of profitability are within the realm of possibility over the next 2-3 years.