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An Excellent Gap to Fit Your Investment

January 31, 2014 | About:

With over 3,000 stores across the world, most of which are located in the U.S., GAP Inc. (GPS) is one of the largest specialty apparel retailers domestically. It offers a great variety of clothing, accessories and personal care products for customers of all ages. Its brands include Gap, Banana Republic, Old Navy, Piperlime and Athleta. All these brands are highly recognized globally, giving the company a narrow economic moat, a rarity in this industry.  Ranging from affordable to luxury concepts, it covers a broad audience that has made of GAP the leading player in the sector.

However, there is some concern that growing competition from local rivals like Abercrombie & Fitch Inc. (ANF) and Ann Inc. (ANN), and international brands such as Inditex may erode the company´s margin. Its increase in input costs, inventory per store levels, and negative international comps are also key factors to analyze.

Nevertheless, GAP´s shares have doubled their value in the last two years and Wall Street analysts project a 17% price rise over the next. So, let´s see how this giant overcomes headwinds and makes its way forward.

Local Pruning, Improved Merchandise and Turnaround Marketing Strategies

During third quarter fiscal 2013, the company achieved high top-line growth and increased its margins. This better-than-expected outcome results from GAP's healthy expenses management and becomes more outstanding given the soft economic environment.

At a domestic level, the company has driven a turnaround marketing strategy that has improved its comps. This major move involved closing weak performing stores in the U.S., reducing its number to 950. In addition, GAP's endeavors to improve inventory store levels through the implementation of an upgraded inventory system that allows stores to fill online orders for merchandise, has resulted in more cost efficiency. It also developed a Reserve in Store feature that gives shoppers the opportunity to set aside products in stores without paying. Altogether, these strategies improved the company´s comparable store sales, which showed year-over-year growth in almost every month from January to November 2013.

The company´s efforts to recapture its core consumer and attract new ones focused also on merchandise improvement. The creation of the global creative center that gathers top talents from the apparel industry resulted in hits like the “Be Bright” campaign, focused on colored denims and bottoms, which boosted GAP sales in 2012.  The creation of a global platform behind each brand also helps to build a consistent message that translates into a stronger brand image.

In regards to international expansion, GAP has a strong potential given the variety of brands it possesses. This allows the company to launch its business matching products and prices with different market needs. E-commerce has also delivered good results so far and the company is continuously working on its improvement. Thus, GAP expects to generate 30% of total sales from overseas and online operations by 2013, versus 27% in fiscal 2012.

A Stock on the Rise

GAP´s shares trade at 13.5 times its trailing earnings, at a significant price discount compared to the Industry Median of 18.5. This becomes more evident if we consider that it is larger and far more profitable than its local peers.  The company has a healthy balance sheet and the ability to generate strong cash flow, which allows it to make large stock repurchases. This results in increasing earnings per share. The company also enhances shareholder value by continuously incrementing its dividends  (so far fiscal 2013 shows 60% increment). In fact, Wall Street analysts project a dividend rise of 2.1% for next year, together with the above-mentioned 17% increase in stock value. And its return on equity amounts to as much as 39.20 compared to the industry average of 9. Also, investment guru Joel Greenblatt (Trades, Portfolio) recently increased his holdings by 82.64%, further encouraging me to feel bullish regarding GAP and it’s potential for future growth.

Disclosure: Vanina Egea holds no position in any stocks mentioned.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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