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Companies with Buybacks: GPS edition

November 29, 2011 | About:
Chandan Dubey

Chandan Dubey

99 followers
This article is fifth in the series of articles about share buybacks and whether the company doing them is returning value to share holders. The previous articles can be found here.

Companies With Buybacks: ISRG Edition

Companies with Buybacks: AMAT Edition

Companies with Buybacks: LOGI Edition

Companies with Buybacks: SBUX Edition

Recent events

The day — May 19, 2011. Gap’s stock price was around $23 but after the market closed, management released first-quarter earnings. The stock sank like a led balloon to $18. The subsequent events in the world and more specifically Europe did not help and the stock sank further to $15.05. We will see if the current market sell-off is justified and given the buybacks of GPS, is it a time to buy?

The Company

The Gap Inc. (GPS) is a clothing retailer based in the U.S., operating more than 3,000 retail stores under three distinct apparel brand names — Gap, budget brand Old Navy, athletic apparel brand Athleta, and urban chic Banana Republic. It also has other brand extensions — GapBody, GapKids and BabyGap. Gap, a familiar brand to most, was founded in 1969 by Doris and Don Fisher with a single store when Don couldn't find a pair of jeans that fit right.

The Gap’s motto is to provide stylish clothing at affordable prices. This has been made increasingly difficult due to hostile retail environment of declining sales, increasing commodity/cotton prices and bad job market. Since CEO Glenn Murphy joined the company in 2007, Gap has reduced its store count and has slowly begun expanding in Europe and Asia. The China expansion seemingly has been quite successful. For more details on its China expansion success, see the following articled by Charles Sizemore.

Gap: Shrinking In America, Growing In China

Management compensation
  • The directors as a group of 10 individuals received $800,000 in cash and each of them received $124,992 in stocks. They received no options.
  • Under the 2011 Long Term Incentive Plan, they received 545,000 stock options and employees received 1.8 million options.The average strike price of these options is $23. Also note that in the current proxy the management is seeking to delete a clause which allows the management to reprice options without shareholder approval. Another 2.4 million RSU’s have been awarded to employees (dollar value: 52.8 million) and $36 million plus $24 million has been reserved for performance-based awards.
  • The whole management holds nearly 23% of shares outstanding. Around 19% of shares are held by members of the board, William and Robert Fisher.
  • The executive committee (a group of five members) received $19 million in salaries, out of which $7.3 million was in restricted stock units and $2.3 million was in stock options.
  • The burn rate is much less than 0.2%.


Shareholder return

Gap’s dividend, although it did not increase every year, still has resulted in a increase from 0.09 to 0.39 (0.57% to 2.23%).

2002200320042005200620072008200920102011
Dividend Paid76M78M79M79M179M265M252M243M234M252M
divided by
Shares Outstanding860M881.5M988.2M991M902M836M794M719M699M641M
Dividend Paid Per Share0.090.090.080.080.200.320.320.340.330.39
Price at Year End15.5223.2121.1217.6419.5021.2813.3920.9522.1417.62
Dividend Yield0.57%0.38%0.38%0.45%1.02%1.49%2.37%1.61%1.51%2.23%


Gap has also been buying shares quite consistently. The following is the table of shares outstanding:

2002200320042005200620072008200920102011
Shares Outstanding860.26M881.48M988.18M991.12M902.31M835.97M794.00M719.00M699.00M641.00M
Stock Bought Back--2.41%-10.80%-0.30%9.84%7.93%5.29%10.43%2.86%9.05%


The outstanding share count has gone down from 860 million in 2001 to 503 million in the most recent quarter. This is a reduction of 41% in shares outstanding.

Balance sheet

Does GPS have the necessary funds for stock buybacks, or like Netflix (NFLX) when it needs money, does it dilute the shareholders at a much lower price? From the third quarter report 2011 we dig up the following figures.

Items (in $millions)July 30, 2011January 29, 2011
Cash$2,1041,561
Total current assets4,6813,926
Goodwill9999
Total asstes7,8067,065
Current liabilities2,1582,095
LT debt1,6060
Total liabilities2,524890
Total equity3,1244,080
3 months ended July 30, 20113 months ended July 30, 2010
Interest expense221


As we see, Gap has just in its most recent quarter taken on a debt of nearly $1.6 billion.



In April 2011, we issued $1.25 billion aggregate principal amount of 5.95% notes (the "Notes") due April 2021 and received proceeds of $1.24 billion in cash, net of underwriting and other fees of $11 million. The net proceeds are available for general corporate purposes, including repurchases of our common stock.

Will GPS need any money to expand or pay debt which it does not have? To see this, let us see if it has been profitable and what the FCF has been like.

2002200320042005200620072008200920102011
Free Cash Flow377.76M935.07M1.90B1.18B951.00M678.00M1.40B981.00M1.59B1.19B


In the last 10 years, GPS had never had even one down year. The FCF has been always strong. And I do not see GPS needing money that it will need to dilute the shares for.

Valuation

Gap is selling for 8.9 billion with current assets for a total liability of $2.1 billion. On a DCF the market is expecting -12.45% growth in FCF at a 15% hurdle rate. Gap is also cheap on other metrics like P/E=9.6, P/S=0.7 and P/CF=5.9.

Key development

Management fired its star designer when they realized that hurting sales denote a far deeper problem than just the bad economy. It indicates that management is meeting the problems head on and trying its hard to put the company on the right track.

If recent organizational changes and new designers also fail to improve the situation, Gap may have larger troubles ahead than stagnant sales. A loss of reputation is very hard to earn back.

Conclusion

The share buyback is a definite buy. The management is very shareholder friendly and the share buyback is returning value to shareholders. I am long on GPS around $18 for $500 at the moment. I am looking to buy more when prices drop.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.0/5 (15 votes)

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