Gap Inc. (NYSE:GPS) is a global specialty retailer offering clothing, accessories and personal care products for men, women and children. Remaining more or less stable post recession, the company’s stock price increased by almost 70% by the end of 2012 driven by its strong financial performance. Our price estimate for Gap Inc. stands at $40, implying a premium of about 10% to the market price.
We believe that this premium can be justified by the retailer’s aggressive marketing, rapid growth in its direct-to-consumer business and market specific expansion. Gap is consolidating its underperforming stores network in the U.S. and expanding in key emerging markets. In addition, the retailer’s direct-to-consumer business is growing fast and it is online channels for marketing.
Strategic Expansion In Different Markets
While Gap Inc. is consolidating its underperforming stores in the U.S., it is looking to expand in select international markets. The retailer reduced the number of Gap stores by about 70 during the period 2009-2012. As a result, its revenue per square foot increased from $370 to $390 during the same period.  Similarly, Old Navy’s revenue per square foot went up from $270 to $300 with the closure of 28 stores. Although we expect the store count to stabilize in the future, increased store efficiency will boost margins and growth in comparable store sales.
International markets with better economic growth prospects and lower competition than the U.S. provide an opportunity to operate with fewer discounts. This is the reason why Gap Inc’s international stores generate significantly more revenue per store than its U.S. stores.  Hence, it makes sense for the retailer to expand its international footprint in lucrative markets such as China.
With a booming middle class and rising disposable income, China has become the second largest apparel market in the world with total apparel sales of about $110 billion (2009 figures). Consulting firm Mckinsey expects this figure to cross $200 billion by the end of 2014.  This explains why Gap opened 30 stores in China last year and plans to add 35 more in fiscal 2013. The retailer will also be opening its affordable luxury brand store Banana Republic in the region.  Another Mckinsey report suggests that while Chinese consumers represented only 1% of the global luxury spending in 1995, they accounted for 27% of the spending in 2012. By 2015, China is estimated to have one-third share of the global luxury market. 
Apart from this, Gap is looking to add 15-20 Old Navy stores in Japan, which marks the beginning of international expansion for this brand. Japan provides ample opportunities for western apparel retailers, which is evident from Urban Outfitters’ (NASDAQ:URBN) successful launch of its Free People brand. Last year, Gap entered nine new countries with 85 franchise stores and plans to add 75 more in fiscal 2013.  This will help the company to create greater brand awareness in new markets. Additionally, the retailer plans to enter Brazil in the latter half of 2013. Being the largest Latin American economy and the fifth largest country in the world, Brazil offers good market potential for U.S. retailers.
Currently, the U.S. apparel industry is witnessing strong growth in the direct-to-consumer channel. Historically, retailers such as Urban Outfitters and Abercrombie & Fitch (NYSE:ANF) have seen substantial revenue growth in this channel. Even Gap’s direct-to-consumer revenues have grown by more than 20% annually since 2010. This trend is likely to continue going forward due to increasing Internet usage, Gap’s mobile apps and mobile-optimized sites.
Back in 1999, online apparel sales in the U.S. constituted only 0.05% of total apparel sales. This figure increased to 1.5% in 2009.  The proportion is still low and there exists huge growth potential for online apparel retail business in the near future. To strengthen this channel, Gap launched an iPad app in 2010 to socialize its customers’ shopping experience.  Moreover, the retailer’s mobile-optimized sites enable customers to browse and shop online as well as locate a nearby store.  Gap also recently launched an e-commerce website in Japan, which completes its online presence in key markets such as Europe, Asia and North America. 
About a year back, Gap launched the “Be Bright” campaign for its seasonal collection in collaboration with Ogilvy.  Through this campaign, the retailer utilized fashion blogs to market its products and attract customers. Gap introduced a website, Styld.by, in partnership with popular fashion and lifestyle blogs such as Lookbook, FabSugar, etc. These blogs seem to be doing well for the retailer.
According to a 2011 Technorati report, consumer trust on traditional media has declined by 46% since 2006.  Around 35% consumers trusted blogs to be credible sources of information and 19% agreed with the idea that they are better written than traditional media sources. Gap’s Styld.by blog partners collectively have about 1 million average unique monthly visitors.  This has helped the retailer generate more interest among customers and improve its brand image. The impact was visible in its recently reported results. 
Our price estimate for Gap Inc. at $40, implying a premium of about 10% to the market price.Notes:
- Gap’s SEC filings [↩] [↩]
- From Mao to Wao: Winning in China’s Booming Apparel Industry, Mckinsey, Jan 2011 [↩]
- Banana Republic Set To Launch In China, South China Morning Post, Aug 15 2012 [↩]
- Chinese shoppers ‘biggest spenders on luxury goods’, South China Morning Post, December 13, 2012 [↩]
- Gap’s Q4 fiscal 2012 earnings transcript, Feb 28 2012 [↩] [↩]
- Calculated using the data available with United States Census Bureau [↩]
- Gap makes shopping more social with ipad app, Mobile Commerce Daily, April 12 2010 [↩]
- Gap broadens mcommerce repertoire via mobile-optimized site, Mobile Commerce Daily, May 26 2011 [↩]
- Gap Inc. launches e-commerce sites in Japan, fibre2fashion, Oct 11 2012 [↩]
- Gap’s New Campaign: “Be Bright”, Branding Magazine, Feb 16 2012 [↩]
- State of the Blogoshpere 2011, Technorati, Nov 4 2011 [↩]
- Gap’s Styld.by campaign uses bloggers to build connections, lonely brand, Mar 6 2012 [↩]