Dive Brief:

• S&P Global on Monday downgraded Gap Inc. in light of the company's persistent struggles amid stiff competition in apparel and trouble at malls, along with the cloudy insight into its planned separation of its Old Navy discount banner. 

• The ratings agency lowered its issuer credit rating and issue-level rating of Gap Inc., both to "BB" from "BB+," according to a report emailed to Retail Dive.

• S&P's outlook on the company is negative, "reflecting that we could lower the rating over the next 12 months based on the outcome of the company's planned spin-off or if the company's overall performance fails to stabilize."

Dive Insight:

Gap Inc. for decades was one of the steadiest apparel retailers, something that more recently was bolstered by its Old Navy banner as the namesake brand declined.

That strength from Old Navy led Gap Inc. executives in February to devise a spinoff plan that they said would allow each side of the business to pursue individualized growth strategies. Instead, with little clarity into those divergent strategies and as Old Navy itself also faltered this year, the plan has introduced a new level of turmoil.

"The downgrade reflects our view that Gap Inc.'s performance struggles will persist as it faces a torrent of competitive headwinds and potential distractions from the planned separation of its core Old Navy brand in mid-2020," S&P analysts wrote, citing "inconsistent execution, fashion misses, and weak traffic trends" that they noted have helped send store comps down 4% year to date and gross margins down some 100 basis points.

The agency painted a dire picture of an apparel giant losing market share to "fast fashion, off-price, and mass-merchandisers" as it suffers from its Gap and Banana Republic brands' dependence on malls. Those two will likely "remain under pressure from secular challenges and eroding margin trends will be difficult to reverse," according to S&P.

It's notable that Old Navy joins those brands at the center of the company's troubles, after supporting it for several years. Previously, declines at Old Navy seemed easily fixed, and would usually bounce back from one quarter to the next. Not so this year, and the brand's challenges couldn't have come at a worse time, with executives seeking to unlock its value through a spinoff. S&P analysts made it clear that Old Navy is now part of the problem.

"The negative outlook reflects our expectation that operating results will remain challenged by ongoing intense competitive pressures and execution risks will persist with all of its key brands, including Old Navy," they wrote. "It also reflects the risk that we could lower the rating based on how the company will be funded following the planned spin-off of Old Navy."

S&P said it is "unlikely to take a positive rating action" without "greater visibility into the company's prospective capital structure and financial policy" following the spinoff, but could upgrade its outlook to stable if Gap Inc.'s work to "strengthen operational execution and restore relevance lead to sustained improvement across all brands, including stabilizing sales and profitability trends while maintaining leverage below 3x."

If anything, interim CEO Robert Fisher, the son of Gap's founder, who took over after the abrupt ouster of Art Peck, last week introduced new worries regarding the company's operations. On a conference call with analysts last Thursday, Fisher noted that "overall complexity that has been building up in the organization over time has led to a lack of focus, operational discipline and efficiency in many areas."

To address that he has convened an executive committee to "streamline operating decisions and drive better accountability during this interim period." That includes Old Navy chief Sonia Syngal and Banana Republic chief Mark Breitbard, who will be responsible for brand leadership. CFO Teri List-Stoll ​will add operational oversight to her role, and Global General Counsel Julie Gruber will consolidate administrative oversight, he said.​

Roxanne Meyer, managing director at MKM Partners, in an email the next day noted that investors had previously expressed skepticism about the wisdom of the separation plan, and that Fisher's description of previously unreported challenges in Gap Inc.'s operations were all the more alarming.