Could Gap Store Profit Margins Continue Growth Pace?
Gap’s (NYSE:GPS) profit margins at its namesake brand stores have been increasing since 2007, driven by successful control of inventory and average unit cost (AUC), leading to higher merchandise margins. Going forward, the overall lower demand in the apparel market caused by a weak economy could result in slower margin growth.
Gap competes with other specialty retailers like Aeropostale (NYSE:ARO), Abercrombie & Fitch (NYSE:ANF), J.Crew Group (NYSE:JCG) and Urban Outfitters (NASDAQ:URBN).
We expect that Gap’s EBITDA margin will increase gradually to 17% by 2016, with promotional activity providing a potential headwind. In comparison, the Trefis community anticipates that margins could reach 19.5% by the end of our forecast period, suggesting an upside of 4% to our price estimate for Gap.
We currently have a Trefis price estimate of $33.87 for Gap Inc.’s stock, well ahead of market value.
Control on Operating Expenses
Gap’s economic model stresses cost control. This means that if Gap spends more in one area, then it will aim to reduce costs in another area so as to maintain discipline on overall expenses.
Gap reduced its marketing expenses by 25% between 2006 and 2008. Although this was followed by a subsequent 18% increase between 2008 and 2009, total operating expenses remained almost flat.
In addition, Gap’s focus on controlling AUC has enabled it to deliver healthy merchandise margins. As the company continues to achieve operational efficiencies, margins could improve further.
Falling Demand in Apparel Industry
The market size of the US apparel industry is estimated to have declined by around 5% in 2009, compared to 2008. This can largely be attributed to falling consumer spending, especially in the upper income and teen demographics, as well as weak personal disposable income levels over the past few quarters. These factors could pressure Gap Stores sales, which would ultimately impact its EBITDA margin.
Trefis Community Forecast
Trefis community forecasts for Gap Stores EBITDA margin indicate a projected increase from 16.2% in 2010 to 19.5% by 2016, compared to the baseline Trefis estimate of an increase from 15.5% in 2010 to 17% during the same period. The community estimates imply an upside of 4% to the Trefis price estimate for Gap’s stock.