Gap Inc (NYSE:GPS) registered a modest comparable store sales growth of 1% in the fourth quarter of fiscal 2013 driven by its strong brand image partially offset by weak consumer spending. Its gross margins shrunk by 280 basis points due to heavy promotional activities during the holiday season. However, considering that a number of the retailer’s peers recorded significant revenue and profit decline during the same period, these results are compelling.
Overall, Gap Inc effectively displayed its resilience to the tough retail environment in 2013, which helped it gain share in the North American apparel market. The retailer has been able to stay a step ahead of its competitors by promptly responding to the hot fashion trends. Going forward, we expect Gap Inc’s growth to continue as it bolsters its small business segments such as e-commerce, Asian operations and Athleta. However, for the current year, the company expects that foreign currency fluctuations will negatively impact its results. 
Our price estimate for Gap Inc is at $50, implying a premium of about 15% to the market price. However, we’re in the process of updating our model in light of the recent earnings release.
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Efforts To Bolster Online Channel Can Make It A Bigger Business
Gap Inc has seen strong growth in its direct-to-consumer revenues over the past few years, which has boosted its results. During 2009-2012, this business grew at an average annual rate of more than 20%. Even though 2013 was particularly weak for apparel retailers, Gap Inc’s online revenues increased by 21%. The company witnessed healthy e-commerce growth in its international markets as well. We expect Gap Inc’s direct business to sustain its growth momentum in the long term backed by its initiatives.
Gap Inc’s mobile apps and mobile-optimized websites have played a vital role in strengthening its Direct business. Its ship-from-stores service, which allows the fulfillment of online orders through store inventories, has enabled the company to not only offer a greater variety of merchandise over the Internet, but to enhance delivery responsiveness and increase store traffic as well. In Q3 last year, Gap Inc launched “find in store” and “reserve in store” services to enhance its customer service and integrate the digital and store channel. The “find in store” function informs the customers where to find the nearest stores and the “reserve in store” service allows them to reserve up to five items online to try in stores. Since buying clothes is a personal experience and online shopping provides convenience, this offers customers the best of both channels. Customer response to these services has been good so far and Gap Inc is planning to market them aggressively to create greater awareness. Additionally, the retailer will expand the “reserve in store” service in all its Gap stores this year. Currently, only half of Gap stores have this service. Alongside, Gap Inc will also be testing self-service kiosks in its stores in the first half of fiscal 2014. 
We believe that such efforts will propel Gap Inc’s direct-to-consumer growth and make it a bigger business for the company in the future. Moreover, they can even help the retailer bridge the gap between its store and online business, and take significant strides towards omni-channel retailing.
Growth In Asia Shows Long Term Promise
Although Asia is not a big market for Gap Inc, it has been expanding aggressively in the region. From 140 stores in 2008, the retailer grew its business to 289 stores in 2013 and is planning to expand further. During fiscal 2013, Gap Inc opened 30 new stores and entered 4 new cities. The company is now present in 21 cities in the region which leaves another 29 cities with a combined population of more than 5 million untapped. Gap Inc’s brand awareness in China touched 70% in 2013, which is significantly more than its peers. We believe that the retailer might be able enjoy the first mover’s advantage in the market, which although is struggling currently, is set to boom in the long term. With rising disposable income and growing urbanization, the Chinese apparel market grew from $110 billion in 2009 to $140 billion in 2012, and is expected to touch $220 billion by 2016.  
Gap Inc initiated Old Navy‘s international expansion in last year and opened 20 stores during fiscal 2013. The retailer plans to add another 25 stores this year along with the brand’s first store in China. Japan is a huge market for apparel players with annual sales of more than $100 billion. Though a longer than anticipated economic crises has weighed on the market’s growth for over a decade, it somewhat recovered in 2012 (+0.4%) due to increased consumer spending. Biggest gainers from this rebound were the top 100 specialty apparel chains (+5.2%) who hold more than half of the apparel market share in Japan.  The region is an important market for affordable brands since Japanese buyers have been buying longer-lasting value focused products. This trend is likely to persist in the future as a consumption tax is expected to go up this year.  This bodes well for Old Navy since it offers a wide range of casual products at affordable prices.
Expansion Of Young Brand Athleta Will Help 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. For this purpose, the retailer is relying on the expansion of its young brand – Athleta. Through Athleta, Gap Inc offers performance driven sports apparel and footwear for women. The retailer is looking to expand the brand’s footprint aggressively in the U.S, which is currently limited to 65 stores. It opened about 30 Athleta stores last year, and plans to take its store count to 100 this year.
We believe that this is a good time for Athleta’s expansion, as its main competitor Lululemon is struggling with bad publicity. According to SW Retail Advisors, Athleta is the number one contender to benefit from Lululemon’s problems, as it has hired some valuable talent and is looking to replicate Lululemon’s success story.  Athleta has started offering free Crossfit, barre, and cardio classes to its customers, in order to shift their interest from Lululemon, which provides only yoga classes. 
- Gap Inc’s Q4 fiscal 2013 earnings transcript, Feb 27 2014 [↩] [↩]
- China’s apparel retail market: $218 industry by 2016, Trans World News, Aug 3 2013 [↩]
- B2C Ecommerce Sales Climbs Worldwide, as Emerging Markets Drive Higher Sales, eMarketer, Jun 27 2013 [↩]
- Japan’s Apparel Market Is Growing Again, The Business Of Fashion, Dec 10 2013 [↩]
- Apparel in Japan, Euromonitor, Jun 2013 [↩]
- The race to muscle Lululemon out of its turf, CNBC, Nov 14 2013 [↩]
- The Sneaky Way Athleta Is Enticing Lululemon’s Customers, Business Insider, Feb 18 2014 [↩]