Gap Inc‘s (NYSE:GPS) comparable store sales (CSS) increased by only 2% in Q1 fiscal 2013, due to the impact of an unusually long winter. The figure for Gap and Old Navy stores was positive, but stood flat for Banana Republic as the U.S. buyers remained cautious about their spending. However, overall revenues increased by 7% primarily driven by 27% growth in direct-to-consumer sales. Gap has performed well over the past few years driven by its strong fundamentals, and we believe that this quarter’s results represented a temporary weakness. The closure of underperforming stores and the focus on expanding smaller brands will assist the company’s growth in North America. In addition to this, a strong online channel and the aggressive expansion in Asian markets bode well for the retailer’s long term outlook. In this analysis, we’ll look at some of the factors that are critical to the company’s future.
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North America: Store Consolidation & Strategies To Gain Market Share
Store Consolidation: Gap Inc has faced problems with its productivity in the past due to high concentration of its stores in North America and outdated products. To address this issue, the retailer closed several underperforming stores which improved its productivity by 5% over the course of three years. See the table below indicating how revenue per square feet has trended as the store count came down.
*Revenue per square feet declined in 2011 as the company couldn’t keep up with the emerging fashion trends
Strategies to Gain Market Share: While Gap Inc is consolidating its main brand networks in North America, it is looking at other ways to gain share in $300+ billion U.S. apparel market. Apart from expanding Banana Republic, the retailer is relying on smaller brands for the 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 35 stores (2012). It opened about 25 Athleta stores in 2012 and has plans to add 30 more in the current fiscal year.  With Lululemon, Athleta’s main competitor, struggling with bad publicity, we believe that it might be a good time for Athleta to expand.  Additionally, Gap Inc is opening physical stores for its formerly exclusive online brand Piperlime (shoes, accessories and handbags) and is expanding its recently acquired Intermix (women’s fashion botique) to online channel. Moreover, GapKids and babyGap are popular brands in their respective segments. 
Strong Direct-To-Consumer Channel Backed By Omni-Channel Initiatives
Despite a small increase in comparable store sales, Gap Inc saw robust 7% revenue growth backed by its direct-to-consumer business. The retailer’s direct revenues jumped by 27%, which is impressive given the size of its online business. Not just Gap Inc, but also retailers like Urban Outfitters (NASDAQ:URBN) and Abercrombie & Fitch (NYSE:ANF) have experienced substantial growth in their direct-to-consumer channels. Online retail is gaining tremendous popularity in the U.S. due to growing Internet usage and the proliferation of smartphones and tablets. This presents a huge opportunity for the growth of online apparel retail market. eMarketer forecasts the online apparel sales to increase from about $45 billion in 2012 to $90 billion in 2016. 
What’s Gap doing on this front?
Gap Inc launched an iPad app in 2010 to make its customer shopping experience more social.  The retailer’s mobile-optimized sites enable customers to browse and shop online as well as locate a nearby store.  Last year, Gap Inc launched an e-commerce website in Japan, which completed its online presence in key markets such as Europe, Asia and North America.
The company is exploring omni-channel possibilities to complement the growth of its direct channel. Omni-channel retailing refers to a seamless shopping experience across all the available channels. Gap Inc recently launched ship-from-stores initiative for Old Navy, wherein online orders can be fulfilled with store inventory.  This service was already available with Gap and Banana Republic. The company believes that when customers do not find products, fits and colors according to their likings over the Internet, they might think that even stores will not have these products.  This can have a negative impact on the store traffic. Gap Inc will also be testing a reserve-in-store service, which will allow the customers to reserve their products online and buy them at stores.  As a result, the customers might end up buying more than what they came for. Omni-channel retailing is gaining popularity in the industry with retailers such American Eagle Outfitters (NYSE:AEO) and Guess (NYSE:GES) working on several initiatives on this front.
Growth In Asia Will Be Important In The Long Term
Asia houses two of the world’s largest apparel markets and is becoming a hub for western apparel retailers. Gap Inc is fueling its expansion in lucrative markets such as China and Japan.
Last year, the retailer stated that it plans to open about 10-15 Old Navy stores in Japan. By the end of Q1 fiscal 2013, it had already opened about nine stores and has received pleasing customer feedback.  Although Japan is still reeling under the impact of prolonged economic weakness, consumers have shown good affinity towards value-focused products.  Japanese government’s Cool Biz campaign, which urges companies to limit air conditioning and save energy, has led to an increase in demand for casual clothing.  Also, Japan’s Internet retail market has grown at a healthy pace despite a lull in distribution patterns and mass merchandising. 
With a booming middle class, increasing urbanization 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 Inc opened 30 stores in China last year and plans to add 35 more in fiscal 2013.  The retailer also plans to open 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.  Although Gap Inc operates only about 230 stores in the region as compared to more than 3,000 overall, we believe that Asia will play a key role in the company’s growth over the longer run. 
Our price estimate for Gap Inc. at $47, implying a premium of about 10% to the market price.Notes:
- Gap’s SEC filings [↩] [↩]
- Gap’s Q1 fiscal 2013 earnings transcript, Mat 23 2013 [↩] [↩]
- The Gap’s CEO Hosts 2013 Investor Meeting, April 17 2013 [↩] [↩]
- Gap’s Q4 fiscal 2012 earnings transcript, Feb 28 2013 [↩] [↩]
- Lululemon Admits to Bad ‘Testing Protocols’ in Aftermath of See Through Yoga Pants Debacle, Fashionista, April 4 2013 [↩]
- Retail Ecommerce Set to Keep a Strong Pace Through 2017, eMarketer, Apr 24 2013 [↩]
- 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’s Q1 fiscal 2013 earnings transcript, May 23 2013 [↩] [↩] [↩]
- Apparel In Japan, Euro Monitor, June 2012 [↩] [↩]
- Japan ‘Super Cool Biz’ Campaign Urges Businessmen To Shed Suits, Save Energy, Huffington Post, Jan 8 2011 [↩]
- China’s population – Peak toil, The Economist, Jan 26 2013 [↩]
- From Mao to Wao: Winning in China’s Booming Apparel Industry, McKinsey, Jan 2011 [↩]
- Chinese shoppers ‘biggest spenders on luxury goods’, South China Morning Post, December 13, 2012 [↩]