Since the launch of its first franchise store in 2006, Gap Inc (NYSE:GPS) has expanded its international footprint to over 40 countries. Last month, the retailer came out with plans to enter new markets in Europe and Latin America. It will open its first stores in Hungary and Paraguay, and will also initiate Banana Republic’s expansion in Mexico.  Gap Inc plans to open two Gap stores in Budapest, Hungary in partnership with Gottex Brands of Trimera Group.
While the idea is to make the best out of a great international city with unique and youthful atmosphere, entering Hungary might not be the best move for the company.  The region’s consumer spending remains weak and second-hand clothing is gaining popularity. Also, Hungarians shop for apparel often in supermarkets over specialty stores for apparel shopping. The future outlook of the country’s apparel market is uncertain and most of the players are likely to focus on improving their productivity instead of increasing their sales. 
- Can Gap’s Price Optimization Strategy Improve Its Profitability?
- Who Relies On Debt More; Gap Inc or Abercrombie & Fitch?
- Comparing Gap Inc’s & Abercrombie’s Expected Returns For 2016
- Are Gap Inc’s Earnings Volatile?
- Are Gap Inc’s Stores Operating Efficiently?
- Why We Lowered Our Price Estimate For Gap Inc By 30%
What’s The Reason For Expansion In Budapest?
Gap Inc’s expansion in Hungary appears to be a move aimed at strengthening its position in Europe by leveraging the tourism industry. Budapest is a big tourist destination with numerous sight seeing locations including Buda Castle Hill, Royal Palace and Heroes’ Square.
For many years, Europe has been the top destination for international tourists with China alone accounting for the bulk of travelers.  This is evident from the fact that Chinese buyers account for 30% of luxury sales in Europe.  In 2012, about 82 million Chinese traveled abroad, and this figure is expected to go up to 200 million by 2020.  Tourism in Europe is likely to get a boost that will justify Gap’s decision to open stores in key tourist locations. The region’s domestic tourism industry is also quite big with about 52% (2011) of EU-27’s population indulging in at least a four-day trip. 
What Makes Hungary A Relatively Weak Apparel Market?
Weak Consumer Spending
The entire European region has been reeling under the impact of the sovereign debt crises and Hungary is no exception. Back in January 2011, the Hungarian government made some structural changes in the personal tax system to boost consumer spending and stimulate the economic growth.  The region had a two rate personal tax system of 17% and 32% , which the government changed to a uniform 16%.  Additionally, it also provided tax credits for children, which helped in reducing tax liabilities for families.  However, instead of spending more, Hungarian consumers started saving and paying their debts, and the retail sales in the region (including apparel) continued to decline.  As the results did not pan out as expected, the government switched back to the previous tax system within six months.  The situation hasn’t improved much since, and a high unemployment rate and weak purchasing power are likely to continue to weigh on the region’s apparel industry’s growth.
Second-Hand Apparel Is More Popular
Used clothing has emerged as a popular product category amid cautious consumer spending and economic weakness. Merchandise is sold by weight instead of units and are usually 10-20 times cheaper than merchandise available in branded apparel chain stores.  The largest second-hand apparel retailer in the region is comparable in size to some of the giants such as Nike (NYSE:NKE) and Zara. 
Interestingly, even the more affluent buyers are moving to second-hand apparel chains in search of branded products. Back in 2010, used clothes industry was estimated to have an apparel market share of 6% to 7%. Going forward, this figure is likely to go up as second-hand apparel retailers continue to expand in popular shopping centers.  Unless they get aggressive about pricing, this trend will make it tough for established branded chains, let alone new players.
Supermarkets Outdo Specialty Stores
Since the debt crises, grocery stores, hypermarkets and supermarkets have become popular destinations for apparel shopping.  As these stores have loyal customer base and a huge and regular store traffic, apparel products gain high visibility. A number of grocery retailers have started offering a broad assortment of apparel, accessories and footwear in their stores that has proved successful. In addition to attractive prices, these retailers have been attentive to the design and quality of their products.  One of the biggest players in the region is Tesco Globál Áruházak Zrt, which holds substantial share in childrenswear market. New branded apparel retailers will have to tackle the competition from these supermarkets in order to survive.
Our price estimate for Gap Inc. at $47, implying a premium of about 10% to the market price.Notes:
- Gap Inc. Announces Global Expansion Plans, Gap Inc, June 3 2013 [↩] [↩]
- Apparel in Hungary, Euromonitor International, Apr 2012 [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩]
- Europe searches for charm to lure Chinese tourists, Reuters, Mar 7 2013 [↩] [↩]
- Luxury spending in Europe hit by drop in tourist demand, Reuters, Apr 2 2013 [↩]
- Tourism Trends, European Commission, Sept 2012 [↩]
- Government introduces changes to tax systems, European Working Conditions Observatory [↩]
- Hungary’s flat-rate personal income tax, Ministry For National Economy [↩]