Gap Inc. (NYSE:GPS) recently released its Q3 fiscal 2012 earnings with an increase of 8% in its revenues and 6% in the comparable store sales growth.  These were driven by strong direct-to-consumer business, where the revenues increased by 23%.  Gap enjoys a strong presence in the online segment in its major markets, and it recently launched an e-commerce platform in Japan. Moreover, as the overall apparel industry is showing signs of improvement with online segment being a valuable driver, we expect Gap’s growth to continue.
In the third quarter, Gap marked the start of its expansion in world’s second largest economy with four store openings in China.  Although the comparable store sales declined in the international market due to tough European economic conditions and weakness in Japanese market, we believe that expansion in China will produce lucrative results for the retailer in the future. Moreover, as the economic situation in Europe improves, the retailer will see a better contribution from the region.
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Online Segment In Apparel Industry Is Picking Up
The increase in comparable store sales was evenly distributed among the Gap North America (7%), Banana Republic (6%) and Old Navy (9%).  This indicates that the growth was not brand specific, rather it was driven by the overall increased sales via the online channel. However, the introduction of more unit inventory at Old Navy stores also contributed to its comparable store sales growth.
The apparel industry on the whole is showing signs of improvement. It is evident from the fact that the players such as Abercrombie & Fitch (NYSE:ANF) and Urban Outfitters (NASDAQ:URBN) have reported substantial growth in direct-to-consumer business in their recent results. The figures were 25% and 22% respectively.  Moreover, American Eagle Outfitters (NYSE:AEO) reported a comparable store sales growth of 9% in its recent quarter.  This implies that Gap has benefited from the on-going revenue trends. With the increasing popularity of online shopping and the recent launch of Gap’s Japan e-commerce, we expect this segment to be a valuable driver for the future as well.
Our Take On The International Business
The international business revenues constitute about 14% of the total revenues excluding Canada.  In the recent quarter, the comparable store sales declined by 3%. However, the decline was less than the third quarter of fiscal 2011 (-10%). This can be attributed to the tough economic environment in Europe, which contributes about 5% to Gap’s revenues. According to the European commission, the economic growth is expected to pick up slightly in 2013.  Although the recovery will be slow, we expect the sales to improve in the region in future.
Moreover, weakness in Japan, which is still recovering from the last year’s natural disaster, also contributed to the decline. Complemented by the launch of e-commerce, we expect Japan to be a better contributor in the future as it is a lucrative market for apparel retailers. For instance, Urban Outfitter’s launch of its Free People brand in Japan saw a good response.
Gap Inc. also opened its first stores in the world’s second largest economy China.  In the current scenario, China provides a huge potential for apparel retailers where retailers such as Coach (NYSE:COH) have registered substantial growth. Moreover, a lack of direct competition from players such as Aeropostale (NYSE:AEO) and Abercrombie & Fitch in the region should inspire Gap to expand aggressively.
Our price estimate for Gap Inc. at $40, implying a premium of about 10% to the market price.Notes: