Gap Inc. (NYSE:GPS) has a good opportunity to expand in Europe considering that its presence in the region is limited compared to North America. However due to the economic downturn, Europe has troubled a number of apparel retailers such as Guess (NYSE:GES), Abercrombie & Fitch (NYSE:ANF), Ralph Lauren (NYSE:RL) and Jones Group (NYSE:JNY). Although the region’s economic growth is likely to remain slow in the near term, its luxury market and Gap’s Banana Republic brand offer good growth potential.
Despite the unfavorable economic environment in Europe, the region’s luxury market has grown steadily over the past few years largely driven by the demand from tourists. Currently, Europe is the largest luxury goods market in the world with annual sales of more than $95 billion. 
Gap’s Banana Republic is an affordable luxury brand that offers casual and tailored apparel, shoes, accessories and personal care products for men and women at higher prices to Gap and Old Navy. The relevant markets for the brand include apparel and footwear, which account for about 30% of the global luxury sales. Gap operates only 10 Banana Republic stores in Europe, and we believe that it should consider expansion given the region’s potential. 
Banana Republic stores constitute more than 15% of the retailer’s value according to our estimates.
What Is The European Luxury Market Like?
Even though Europe has been reeling under the impact of debt crises, the sustained demand from tourists has fueled the luxury market’s growth. According to Bain & Company’s estimates, the personal luxury goods market in Europe stood at around €75 billion ($96.1 billion) in 2012 (5% growth). Although the growth was slow as compared to the prior year’s and there has been a slight drop in the tourist demand, the region still holds 35% share of the global luxury goods market.  
Tourism has been the key driver as the demand from local consumers has waned. Chinese customers have become increasingly important and now account for about 30% of the industry wide luxury sales in the region. According to analysis by TUI Think Tank and Z_punkt (a strategy and foresight consultancy), an estimated 3.8 million Chinese people traveled to Europe in 2010 and this figure is expected to grow by four times by 2020. Hence, Gap has an opportunity to leverage the growing demand from Chinese shoppers in the region. Moreover, the increasing tourist travel from regions such as Russia, Japan, Brazil, India etc. has further complemented the growth in Europe’s luxury market. 
The flip side is that the demand for luxury products from domestic consumers has subsided. According to a study conducted by consulting firm McKinsey, more than 50% of European consumers reported that they bought fewer luxury products in 2011 as compared to the prior year. Moreover, they are increasingly looking for bargain shopping as compared to full price shopping. 
What Expansion Path Can Banana Republic Take?
Even though Europe holds good potential, the demand for luxury products has not been consistent throughout the region. Southern Europe (including Italy and France) has been the worst affected by the debt crisis. In France, the growth in Chinese spending declined from 62% in October 2012 to 38% in February 2013. Italy’s retail association Confesercenti forecasted a 10-15% decline in the number of tourists during Easter this year as compared to the last year. 
On the other hand, the German luxury market has seen strong support from the growing interest of Germans in luxury products, especially younger shoppers. In 2011, the country’s luxury market posted 16% growth, which was higher than Europe’s industry average.  The luxury market in Eastern Europe (especially Poland) and Russia is also growing at a healthy pace due to better economic prospects in the regions. 
Given its focus on footwear and apparel, Banana Republic can target the estimate $30 billion European luxury goods market.  Although the brand might not be able to cater to all of it since it’s an affordable luxury brand, the market potential is still large. Since Banana Republic is only at its initial stage of expansion, we believe that it should target the most lucrative markets from the beginning. For estimating the brand’s likely expansion pace in the region, we consider the following benchmarks.
Ralph Lauren, a luxury lifestyle retailer, operates only 26 retail and 35 factory stores in Europe (March 2012), but it sells its products through more than 4,300 wholesale stores indicating its wide reach. Over the last three years, Gap has opened about six namesake stores annually in the region. However, since Europe provides better potential for luxury brands, we believe that Banana Republic can expand at a faster pace. Also, Banana Republic has opened about 14 stores annually in the U.S. over the last three years.
Given these benchmarks, we believe that Gap can open about 10-12 Banana Republic stores annually in the next five-six years in lucrative European markets. If the retailer does that, it can slightly improve its store productivity as well. Also, Gap launched its Banana Republic e-commerce site for Europe in 2011, and we expect it to garner good results over the next few years.  Overall we believe that there could be a potential potential upside of 5-10% to our price estimate if Gap can effectively target Europe’s luxury goods market in the coming years.
Our price estimate for Gap Inc. at $43, implying a premium of about 5% to the market price.Notes:
- Bain projects global luxury goods market will grow overall by 10% in 2012, though major structural shifts in market emerge, Bain & Company, October 15, 2012 [↩] [↩]
- Gap’s SEC filings [↩]
- Luxury spending in Europe hit by drop in tourist demand, Reuters, Apr 2 2013 [↩] [↩]
- New Chinese tourists in Europe from 2017, Z-punkt [↩]
- Domestic consumers: The “Sleeping Beauty” of European luxury, McKinsey & Company, February 2012 [↩]
- Roland berger study on the luxury goods market: Germany has the biggest potential in Europe, Roland Berger, April 16, 2012 [↩]
- The Luxury Goods Market In Poland, KPMG [↩]
- 30% of $96 billion, using global share of luxury apparel and footwear sales as a proxy for Europe as well [↩]
- Gap Inc. Continues International Expansion Launching Online Shopping In Eight Additional European Countries, Gap Inc., Feb 9 2011 [↩]