Retail Competition Could Hurt Gap Stock

Gap (NYSE: GPS) is a global specialty retailer of apparel and accessories. The Gap stores constitute nearly 28% of the $34 Trefis price estimate for Gap’s stock. While we are generally optimistic about Gap’s growth prospects over the next few years, we do have concerns about the Gap stores division’s lack of differentiation, which could put downward pressure on sales in a highly competitive and fragmented U.S. apparel market.

Gap’s revenue per square foot expected to grow

Revenue per square foot for Gap stores slipped from $430 in 2005 to $390 in 2009, driven by falling comparable store sales. This unhappy tendency started in the late 1990s, when the company began losing touch with emerging fashion trends. Failed marketing campaigns and poor real estate decisions left Gap with too many stores and falling sales. In addition, Gap alienated its core customer base by moving away from signature basics into younger, trendier styles.

Between now and 2016, we expect revenues per square foot to increase, as the company has significantly reduced its store base and launched some successful marketing campaigns to reconnect with its target demographic.

Revenues per square foot also declined between 2005 and 2008 for Gap’s other retail brands, Old Navy and Banana Republic. Both recovered in 2009 and may perform better than Gap stores during our forecast period. Old Navy operates in the value price segment, which gained popularity during the recent economic slowdown. Banana Republic sells affordable luxury clothing, demand for which is expected to increase as the economy recovers and consumer spending picks up.

However, Gap’s business model can easily be replicated

In the 1990s, Gap emerged as one of the first national specialty retail chains in the U.S., differentiating itself by offering stylish clothing at affordable prices. But as Gap grew, its large store base led to longer procurement cycles and lower inventory turn rates. And Gap’s business model was easily replicated because it lacked strong product differentiation in an industry with low barriers to entry and minimal switching costs.

Downside to Gap’s stock

In an indication that Gap’s fortunes might be improving, revenues per square foot recovered slightly in 2009, compared to declines for major retailers like Abercrombie & Fitch (NYSE:ANF) and American Eagle (NYSE:AEO). But unless Gap manages to differentiate its business model and/or product offerings, its revenues per square foot may stagnate at current levels. As a result, there could be as much as a 5% downside to our current forecast for Gap’s stock. You can modify our revenue-per-square-foot forecast to see its impact on the $34 Trefis price estimate for Gap’s stock.