Gap Inc‘s (NYSE:GPS) international growth has been slower than its U.S. growth of late. This can be attributed to the weakness in Europe’s economy and Japan’s slow recovery from the natural disaster last year. Nevertheless, these markets provide good potential for the retailer in the long run. Gap opened its first outlet stores in China last year, which have performed fairly well. The region is quite important for western apparel retailers due to its huge growth potential. Towards the end of 2012, Gap also came out with a plan to enter Brazil as well. As one of the biggest emerging markets, Brazil is expected to generate promising results.
Gap operates more than 350 stores in international markets including the U.K., France, Ireland and Japan, which contribute about 15% to its overall revenues.
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Temporary Weakness In Europe And Japan
Revenues from Gap’s international business have declined over the past year due to tough economic conditions in Europe and a natural disaster in Japan. In Q3 fiscal 2012, comparable store sales dropped by 3% following a 10% decline in the prior year’s third quarter.  A weak European economy has also troubled retailers such as Guess? (NYSE:GES) and Nike (NYSE:NKE). However, once the economy picks up, we expect to see increased sales and marketing efforts from U.S. apparel retailers to tap the region’s potential. The European Commission expects a gradual improvement in the economy over the next few years, which means Gap’s recovery might start soon. 
A weak Japan, which is still recovering from last year’s natural disaster, has also contributed to Gap’s comparable store sales decline. Complemented by the launch of e-commerce, we expect the retailer to do better in this region. For instance, Urban Outfitters’ launch of its Free People brand in Japan has received good customer response.
Huge Potential In China
China has become the focal point of the global apparel industry due to its booming middle class and increasing fashion consciousness. Abercrombie & Fitch’s initial stores have been successful in the region. Additionally, semi-luxury retailer Coach (NYSE:COH) has flourished in the region, recording 40% growth in its last two quarters.  It serves Gap right to expand its namesake brand (which is value focused) as well as Banana Republic (which sells products at higher price points) in the region. Towards the latter part of 2012, Gap opened its first outlet stores in China which have delivered promising results. Additionally, a lack of significant competition from western retailers could enable Gap to expand faster in the region.
Brazil Is A Lucrative Market For Gap
Brazil is the largest economy in Latin America and the fifth largest country in the world, and it offers good market potential for the U.S. retailers. As one of the major emerging markets, Brazil will provide a large base for fashion conscious customers with higher disposable incomes in the future. Gap plans to open its first branded store in Sao Paulo (the largest city in Brazil) in fall of 2013.
We note that Wal-Mart‘s (NYSE:WMT) Brazilian operations have been growing rapidly. For the past two quarters, its revenues have increased by 10-11% and comparable store sales have grown by more than 5%.  Although the comparison of an apparel retailer with Wal-Mart is not exactly valid, the latter can be regarded as a measure of confidence that customers have in brands that offer good quality products at compelling prices.
Moreover, Gap’s main competitors such as Abercrombie & Fitch (NYSE:ANF), American Eagle Outfitters (NYSE:AEO) and Aeropostale (NYSE:AEO) do not have a presence in Brazil. Even if these retailers plan to enter this market in the future, Gap will still have the first mover advantage.
Our price estimate for Gap Inc. at $39, implying a premium of about 20% to the market price.Notes: