Investing.com -- Moody's (NYSE: MCO ) Ratings today upgraded The Gap, Inc. (NYSE: GAP )'s corporate family rating (CFR) to Ba2 from Ba3 and its probability of default rating (PDR) to Ba2-PD from Ba3-PD. The ratings of the company's senior unsecured notes also saw an upgrade to Ba3 from B1. The company's speculative grade liquidity rating (SGL) remains unchanged at SGL-1, with a stable outlook.

The upgrade is a result of significant improvements in Gap's operating performance and profitability within the first three quarters of the current fiscal year. This has been attributed to expanded margins due to lower input costs, better inventory management, and a decrease in promotional activities.

Despite challenges anticipated in the sector for 2025, stemming from the discretionary nature of the product and a difficult consumer spending environment, Moody's expects Gap to maintain its current operating performance trajectory. This prediction was made by Mickey Chadha, Vice President of Moody's Ratings.

Gap's Ba2 CFR reflects its solid credit metrics and very good liquidity. The company's debt/EBITDA improved to 2.2x for the LTM period ending November 2, 2024, down from 4.9x at the end of fiscal 2022. Moody's anticipates that debt/EBITDA will remain around 2.2x and EBIT/interest to be about 4.3x over the next 12 months.

The company has shown improvement in all of its brands and profitability, with increased gross margins. Lower inventory levels have led to more profitable sales, less promotional activity, and lower input costs. Gap has also reduced operating expenses through strategic cost cuts and store rationalization.

Gap's largest brand, Old Navy, has started to see growth in comparable store sales in 2024 after a decline in 2022 and 2023. However, the Banana Republic brand continues to show some relative weakness in the topline. The company's good market position in the specialty apparel market, ownership of specialty apparel brands, and low amount of funded debt support the rating.

Investments in its online and mobile business have strengthened Gap's operational profile and improved its customer experience. The integration of its online and store experiences also supports its efforts to increase customer conversion.

Gap's SGL-1 rating is supported by its very good liquidity, with $2.2 billion in cash, cash equivalents, and short-term investments at the end of the third quarter of fiscal 2024. The company also generated about $880 million in free cash flow for the LTM 3Q2024 and has no borrowings under its $2.2 billion asset-based revolving credit facility. Moody's expects free cash flow to remain healthy in 2025.

The stable outlook reflects Moody's expectation that credit metrics will not deteriorate. This is due to disciplined inventory management expected to continue supporting healthy operating margins with modest topline growth. The outlook also reflects the company's very good liquidity and moderate debt levels.

The Gap, Inc., headquartered in San Francisco, California, is a leading global retailer offering clothing and accessories for men, women, and children under its Gap, Banana Republic, Old Navy, and Athleta brands. As of November 2, 2024, its net sales were approximately $15.2 billion. The company operates 2,544 company-operated stores and 1059 franchise stores across around 40 countries. Its products are also available online through company-owned and franchise websites and through third-party arrangements.

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