Having performed well through most of fiscal 2013, Gap Inc‘s (NYSE:GPS) comparable store sales declined in September 2013 due to prevailing retail market weakness. The company’s net sales remained flat and comparable store sales decreased by 3% compared to a 6% increase in September 2012.  This weak performance is attributable to a subdued U.S. apparel market caused by cautious consumer spending and a change in spending patterns.
Although the month was challenging, Gap Inc’s management believes that it can still deliver on its full-year goals. We also remain optimistic on the company’s long term outlook since it has performed well in the past when most apparel retailers in the U.S. were struggling. Growth in Gap Inc’s e-commerce business and aggressive international expansion support our bullish outlook.
Our price estimate for Gap Inc. at $50 implies a premium of about 25% to the market price.
Weak Retail Market Weighed On September Results
The back-to-school season this year was particularly weak for apparel retailers in the U.S. due to the impact of payroll tax hike and high unemployment. At the start of the season, the National Retail Federation (NRF) conducted a survey that suggested a sharp decline in consumer spending during the back-to-school season. According to NRF, spending by families with school-age children will decline by almost 8% during this season compared to the same period last year. Moreover, average spending by college students and their families was also expected to decline by a similar amount.  Also, there has been a change in consumer spending patterns as consumers are diverting their spending to houses and cars to take advantage of low interest rates. As a result, they are holding back on purchasing smaller products such as apparel and accessories. 
As a result, U.S. retailers are relying on deep discounts to win back customers, which is weighing heavily on their growth. According to the Commerce Department, retail sales in August excluding the automotive sector increased by just 0.1%.  While Gap Inc managed to post positive growth in August, it faltered to the industry weakness in September. The comparable store sales decline was more profound for Banana Republic, which is a relatively expensive brand, confirming that U.S. buyers are scaling back their spending on non-discretionary products. Other apparel retailers such as Zumiez Inc, The Buckle Inc and American Apparel Inc also posted comparable store sales declines during September. 
However, E-Commerce Growth Should Drive The Company In The Long-Term
Direct-to-consumer channel (mainly e-commerce) is the second most important division for Gap Inc, accounting for about 28% of its value, according to our estimates. The overall online apparel retail industry has shown robust growth over the past few years and Gap Inc has been at its forefront. The company’s e-commerce revenues have increased by more than 60% during the last two years and they further jumped 27% during the first two 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, the retailer’s own efforts such as the 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 Gap Inc’s long-term growth.
Continued International Expansion Will Also Help
Expanding in international markets not only opens up new revenue channels, but also helps in diversifying geographical risk. Contrary to its peers such as Abercrombie & Fitch (NYSE:ANF), Aeropostale (NYSE:ARO), Urban Outfitters (NASDAQ:URBN) and American Eagle Outfitters (NYSE:AEO), Gap Inc has been aggressive with its international expansion. The company opened 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. Notes:
- Gap Inc. Reports September Sales, Gap Inc, Oct 10 2013 [↩]
- On The Heels To Historically High Back-To-School Season, 2013 Spending Expectations Decrease, National Retail Federation, Jul 18 2013 [↩]
- U.S. retailers rely on deep discounts to win back-to-school shoppers, Reuters, Sept 5 2013 [↩]
- Forecast Envisions A Weak Holiday Season, The Wall Street Journal, Sept 17 2013 [↩]
- U.S. retailers’ September sales rise modestly, shoppers wary, Reuters, Oct 10 2013 [↩]
- Gap Inc’s SEC filings [↩]
- 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 [↩]
- Gap’s Q2 fiscal 2013 earnings transcript, Aug 22 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 [↩]