Gap Inc. (NYSE:GPS) posted strong results in Q2 fiscal 2013, registering a comparable store sales growth of 5%. Amid a highly promotional environment, the retailer’s profits jumped 25% accompanied by a slight increase in its gross margins. During the quarter, teen buyers showed low brand loyalty as they moved to other trendy brands such as Gap, Zara, and Forever 21, abandoning retailers such as Aeropostale (NYSE:ARO), American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF). Gap Inc.’s comparable store sales have grown strongly during the past six quarters, and the retailer is on track with its plan to increase its apparel market share in the U.S. from 3.9% (2012) to around 4.5%. 
This is a moment to celebrate for Gap Inc., which was once struggling to keep up with the emerging fashion trends. The retailer has done well in responding to changing fashion tastes and has been quite aggressive with its marketing. Its business will find further support from continued international expansion and e-commerce growth. Let’s take a look at what’s working for Gap Inc.
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Responsiveness To Changing Fashion Tastes
Gap Inc.’s ability to remain on top of changing fashion is one of its main strengths. Last year, it did a complete overhaul of its top level management and appointed separate heads for different divisions and brands. With this, the company was able to specifically focus on every brand in every region, which enabled it to quickly identify and respond to the fashion demand in different markets. 
The company’s management mentioned that the apparel retailers in the industry usually persist with a single brand to build up strong brand loyalty.  However, differentiating the company into three main brands – Gap, Old Navy, and Banana Republic at different price points has worked well for Gap Inc. as it is able to tap a larger customer demographic. Moreover, the retailer does not have to be concerned about the overlap of these brands due to its individual focus on them. Strong demand for Gap Inc.’s fashion apparel led to a sharp rise in the number of units sold per transaction and conversion rates in the second quarter. 
Maintaining optimum inventory levels allows Gap Inc. to launch new collections in a timely fashion. In the second quarter, the company’s inventory grew by 6% which was almost in line with the comparable store sales growth.  The retailer operates a flexible supply chain with over 1,000 vendors located in 40 countries with none of them accounting for more than 5% of the goods. Moreover, about 98% of the inventory is sourced from outside the U.S., which helps it offer good products at competitive prices. 
Gap Inc. has been aggressive with its marketing and has placed a greater focus on reaching out to its customers through fashion blogs in the recent quarters. Last year, the retailer launched a “Be Bright” campaign and introduced a website, Styld.by, in partnership with popular fashion and lifestyle blogs such as Lookbook and FabSugar. A 2011 Technorati report suggest that 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 Inc.’s blog partners collectively have over 1 million average unique monthly visitors, indicating the retailer’s wide reach.  This strategy has worked well for the company so far.
In its Q2 earnings call, Gap Inc. stated that it is looking to go back to television advertisements for the purpose of promotions. The company feels that the time is right to bolster its marketing campaign as its products have found good acceptance among the buyers.  Television ads will serve as a valuable medium to showcase what’s new with the brand and what it lacked before as well as help the company in getting back lost customers.  Additionally, Banana Republic has partnered with Issa London to launch a limited edition capsule collection inspired by safari styles and signature prints for the third quarter in a bid to revive its comparable store sales, which saw a decline of 1% during the second quarter. 
Continued International Expansion
Contrary to its peers such as Abercrombie & Fitch, Aeropostale, Urban Outfitters (NASDAQ:URBN) and American Eagle Outfitters, Gap Inc. has been aggressive with its international expansion. The company opened about 30 of its namesake stores in China last year and plans to open about 35 stores this year along with its first Banana Republic store. Following the launch of Old Navy stores in Japan, Gap Inc. stated that it will introduce the brand in China in fiscal 2014.  China is the second largest apparel market in the world with a huge pool of fashion conscious customers. Total apparel sales in the region increased from $110 billion in 2009 to $140 billion in 2012, and are expected to reach $220 billion by 2016.  
Gap Inc. is also planning to launch its namesake stores in Taiwan, which is gaining traction due to increased presence of fast-fashion brands, improving consumer confidence and growth in online sales.  Apart from Asia, the retailer can continue expanding in Europe as the region’s economy is showing some signs of revival. Two of the largest economies in the region – Germany and France – grew faster than expected in the second quarter indicating that the euro zone is recovering from its recession. 
E-Commerce Business Remains The Key Driver
Gap Inc. has been at the forefront of the growth in the online apparel retail industry with revenues growing by over 60% over the last two years. The company’s online sales further jumped 27% during both the quarters of fiscal 2013, despite a difficult retail environment. We believe that this growth will continue as the outlook for the global online retail market is very optimistic. eMarketer forecasts online apparel sales in the U.S. to increase to about $90 billion by 2016, up from $45 billion in 2012.  In Europe, online retail sales are expected to grow at a compounded annual growth rate of 11% for the next five years.  Given the trend in the U.S., online apparel retail will likely exceed the overall industry growth. China is no different as eMarketer forecasts e-commerce sales in China to increase from $110 billion in 2012 to $440 billion in 2016.  Gap Inc. plans to launch an e-commerce website in the region in the first half of fiscal 2014. 
In addition to the industry growth, Gap Inc.’s own efforts such as launch of mobile apps, mobile-optimized sites and ship-from-store services can help it remain a step ahead. Overall, this channel appears to be well poised to boost the retailer’s long term growth.
Our price estimate for Gap Inc. at $50, implies a premium of about 20% to the market price. However, we are in the process of updating the model in light of the recent earnings.Notes:
- The Gap’s CEO Hosts 2013 Investor Meeting, April 17 2013 [↩]
- Gap revenue beats as same-store-sales rise 5%, CNBC, Aug 22 2013 [↩]
- Gap’s Q2 fiscal 2013 earnings transcript, Aug 22 2013 [↩] [↩] [↩] [↩] [↩] [↩]
- Gap Earnings: Retailer Avoids Teen Slump, The Wall Street Journal, Aug 22 2013 [↩]
- Gap Inc.’s SEC filings [↩]
- State of the Blogoshpere 2011, Technorati, Nov 4 2011 [↩]
- Gap’s Styld.by campaign uses bloggers to build connections, lonely brand, Mar 6 2012 [↩]
- Banana Republic Partners Issa On Capsule Collection, Business Journal, Apr 14 2013 [↩]
- From Mao to Wao: Winning in China’s Booming Apparel Industry, McKinsey, Jan 2011 [↩]
- China’s apparel retail market: $218 industry by 2016, Trans World News, Aug 3 2013 [↩]
- Apparel in Taiwan, Euromonitor, Jun 2013 [↩]
- Germany, France haul euro zone out of recession, Reuters, Aug 14 2013 [↩]
- Retail Ecommerce Set To Keep A Strong Pace Through 2017, eMarketer, Apr 24 2013 [↩]
- US Online Retail Sales To Reach $370 B By 2017; EUR 191B In Europe, Forbes, Mar 14 2013 [↩]
- B2C Ecommerce Sales Climbs Worldwide, as Emerging Markets Drive Higher Sales, eMarketer, Jun 27 2013 [↩]