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Investment Overview for Gap Inc. (NYSE:GPS)
WHAT HAS CHANGED?
- Gap reported its second quarter results on August 18, 2016. While the company beat consensus estimates on both EPS and revenue, both metrics were down as compared to the prior year. The company reported a 24% fall in operating income, and a 43% drop in net income for the second quarter, while also offering a downbeat outlook for the year. The company forecast full-year EPS to be in the $1.87 to $1.92 range, down significantly from its prior expectation of $2.20 to $2.25. As noted by CEO Art Peck, the pace of improvement in the business remains unsatisfying, but the company shows signs of progress. This was demonstrated in the healthier merchandise margins, reflecting reduced promotions and markdowns. Gap has also been focusing on controlling inventories and shortening production times, as it is striving to replicate the success of its Old Navy brand at its namesake brand and at Banana Republic. The company has been attempting to refresh its Banana Republic line, with little success however, reflected in a sixth straight quarter of comparable store sales decline.
- The company recently announced a slip in the revenue and same-stores sales for the month of July, as well as for the second quarter. This coming on the back of promising results in June, when the company posted 2% comparable sales growth, is definitely disappointing. Given the general weakness in the retail industry, and increasing competition from fast-fashion and internet retailers, we expect the company's Old Navy brand to be the standout performer, with falling revenue per square foot in its namesake Gap brand, and its higher-priced Banana Republic brand. The company has been struggling with falling sales as of late, and the stock has declined considerably in the face of a gloomy outlook. While the second quarter comparable sales improved on a sequential basis, they remained in negative territory, and worsened in comparison to June results. This implies that a turnaround isn't in the cards, as of now. For the quarter, the comps declined 2%, on a 3% decline at Gap, a 9% fall at Banana Republic, and flat performance at Old Navy. This performance was better than that for the first quarter, when the company reported a 5% comparable sales decline. After the positive performance in June, up 2%, driven by 5% growth at Old Navy, July sales plunged 4%, with a 4% fall at Gap, 14% decline at Banana Republic, and a flat performance at Old Navy.
- The company faces a number of problems, despite the positive seen in the improvement of June comps sales. In Banana Republic and Old Navy, the company has made adjustments to the ticket prices, where it was felt that the initial prices weren't competitive. Another problem facing the company is its excessive promotional strategy. The company's three main brands remain heavily discounted, and while this was recognized by the management, they failed to act on it in the first quarter. According to research by Wells Fargo, both the Gap and Banana Republic brands were more promotional than they were in the same period last year, while Old Navy was similarly promotional. In May, Gap Inc. CEO Art Peck announced that steps were being taken to "tighten up" their discounts. The company is also not immune to the broader challenges facing the retail industry, including lower spending on clothing, as compared to a greater preference for dining out and travel. Moreover, brick and mortar stores must also compete against numerous design labels that can market themselves directly to consumers via the internet.
- Old Navy Stores EBITDA Margin: EBITDA margins for Old Navy stores declined from 26.1% in 2010 to 22.1% in 2011 due to a sudden rise in cotton costs owing to floods in major cotton producing areas, and excessive promotional activities in domestic operations. The margins rebounded to 24.5% in 2012 with lower cotton prices and better product mix. This improvement continued in 2013 as margins increased slightly to 25.3% with better expense leverage. In 2015 however, margins fell to 22.7% on account of heavy promotional activities and higher proportion of online orders. Going forward, we expect Old Navy's margins to continue to fall at a slow pace on account of pricing pressure from fast-fashion brands and expansion of omni-channel retailing. If the decline is faster than anticipated due to merchandise goof-ups and competitive pressure, and margins by 2021 reach 18%, there can be about 5% downside to our price estimate for Gap Inc. Conversely, if Old Navy's margins improve at a rapid rate and reach 23% by the end of our forecast period driven by better operating leverage, higher store traffic, and fewer discounts, there could be 5% upside to our Trefis price estimate.
- Gap Store Revenue per Square Foot: Gap store revenue per square feet increased consistently from $410 in 2009 to $491 in 2013 driven by consolidation of under-perfoming stores, online revenue growth, and strong customer response to the brand's products. However, the figure declined to $470 in 2014 and $446 in 2015, as buyers across the industry scaled back their spending on premium basic products and spent on fast fashion brands instead. For the next two years, we expect the figure to decline further due to continued portfolio weakness, but we expect marginal recovery thereafter driven by growth of smaller brands - Athleta, Intermix, GapKids, and babyGap, rise in online revenues, development of omni-channel platform, and store consolidation. We project the figure to reach $450 by the end our forecast period. However, if Gap's revenue per square foot continues to decline at a moderate rate, there can be more than 5% downside to our price estimate. On the contrary, if the retailer's aforementioned strategies push the figure to $480 instead, there can be about 5% upside to our price estimate for Gap Inc.
Gap is a global specialty retailer offering clothing, accessories, and personal care products for men, women, and children. It markets its products under the Gap, Old Navy, Banana Republic, Athleta, GapKids, babyGap, and Intermix brands.
Gap operates stores in North America, and several countries in Europe and Asia. It is one of the few U.S. apparel retailers who have a decent international presence. The company also sells its products online through web-based stores for each of its brands. The company has recently changed its reporting structure due to its adoption of omni-channel retailing. It no longer reports separate e-commerce revenues but includes them in individual brands' revenues. In addition to this, Gap has franchise agreements with unaffiliated franchisees to operate Gap, Old Navy, and Banana Republic stores in many countries.
The retailer operates three different brands for three main demographics: Old Navy for cost and fashion conscious teenagers, Gap for young adults, and Banana Republic for more affluent and relatively older customers.
Gap stores are more valuable than Old Navy and Banana Republic stores in the U.S. because of the following reasons:
Far greater number of Gap stores present in comparison to Old Navy and Banana Republic
The number of Gap stores operated by the company as of 2015 was 1,346. In comparison, the total number of Old Navy stores and Banana Republic stores was 1,095 and 673 respectively.
'Revenue per Square Foot' for Gap stores is higher than that of Old Navy and lower than that of Banana Republic
Gap stores generate revenue per square foot (including online sales) of $446, which is much higher than the $369 generated for Old Navy stores. It is lower than $492 generated by its semi-luxury Banana Republic stores. As Banana Republic stores are fewer in number, their higher revenue per square foot does not entirely offset the value of the Gap stores.
Average size for Old Navy stores is much greater than that of Gap and Banana Republic
The average size of a typical Old Navy store is 16,712 per square foot. This compares to 9,423 per square foot and 8,024 per square foot for Gap and Banana Republic stores, respectively. The Old Navy brand operates in the value priced segment where margins are lower. However, due to the significantly larger size of stores, the brand is able to generate significant value for the company by selling more units. Since the beginning of 2007, the company has been downsizing the square footage of Old Navy stores. The trend was more clearly visible in 2015 and we expect this to continue going ahead.
Development of omni-channel platform
An omni-channel platform enables retailers to engage customers irrespective of the shopping channel they prefer. A while back, Gap Inc. launched its ship-from-store service, which allows the fulfillment of online orders through store inventories. This service not only enables the company to offer a greater variety of merchandise over the Internet, but also helps it improve delivery responsiveness and store traffic. A couple of years back, Gap Inc. launched “find in store” and “reserve in store” services to enhance its customer service and integrate the digital and store channel. The “find in store” function informs the customers where to find the nearest stores and the “reserve in store” service allows them to reserve up to five items online to try in stores. Since buying clothes is a personal experience and online shopping provides convenience, this offers customers the best of both channels. Encouraged by the pleasing response, the company expanded its “reserve in store” to all Gap Stores in the U.S. in 2014. In addition, it began testing a new order in store capability later in the year, which gives customers an instant access to expanded merchandise offerings over the Internet.
Online apparel sales in the U.S. are growing at a robust pace due to growing internet usage and proliferation of smartphones and tablets. eMarketer forecasts the online apparel sales to increase from about $60 billion in 2015 to $86 billion in 2018.
Efforts to gain market share in the U.S.
While Gap Inc. is consolidating its main brand networks in North America, it is looking at other ways to gain share in the $300+ billion U.S. apparel market. Apart from expanding Banana Republic, the retailer is relying on smaller brands for this purpose. In an investor meeting held in April 2013, the company stated that it will focus on Athleta, Piperlime, Intermix, GapKids, and babyGap to grow its business in North America. Through Athleta, Gap Inc. offers performance driven sports apparel and footwear for women. The retailer is planning to expand the brand’s footprint in the U.S., which is currently limited to just 120 stores (2015).
The company opened about 25 Athleta stores in 2012, added another 30 in 2013, 36 in 2014, and 19 in 2015. Gap Inc. plans to continue the expansion of this brand going forward. Recently, Gap Inc. decided to discontinue Piperlime (shoes, accessories, and handbags) to focus on other promising areas. It is expanding Intermix's (women’s fashion boutique) online as well as store presence. Currently, Intermix has 42 stores in the country.
Gap's targeted international expansion
International expansion is one of the key long-term strategies of Gap. The company is particularly focused on emerging economies such as China, which has become the second largest apparel market in the world with a booming middle class, rising disposable income, and growing urbanization. The company opened 38 Gap stores in Asia in 2014 and 39 in 2015, and most of them were in China.
The retailer initiated the international expansion of its Old Navy brand in 2013 as it opened 17 stores in Japan. In the subsequent year, Old Navy's store count in Asia went up to 43 and it settled at 65 in 2015. The company also launched the brand's first store in China and is planning to open more stores in the years to come.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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