Is Store Consolidation Actually Working Out For Gap Inc?

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Apparel vendor Gap Inc (NYSE:GPS) started closing domestic stores for its namesake brand and Old Navy several years ago, after their large store networks began cannibalizing their own sales. Other reasons that triggered and kept the store consolidation going were an industry-wide decline in foot traffic (thanks to the online shift) and the gradual adoption of the omni-channel model. The company has closed a total of close to 300 domestic stores for Gap and Old Navy combined since 2009, realizing that its position in the market had saturated. For its consolidation, Gap Inc has mainly identified stores whose revenue contribution to the company is much weaker than expense contribution. While the idea behind such closures is almost apparent, has this strategy actually worked out for Gap Inc?

An analysis of the company’s revenue and expense metrics shows that while revenue per store has gone up during the last six-year store consolidation period, expenses per store were not allowed to increase comparably. This is exactly what the the strategy was intended to achieve. In fact, since online retailing is expected to become a major contributor to overall sales at a certain point in the future, keeping expenses under control will be a major task for Gap Inc. Online by nature is a low-margin business and its rapid growth relative to the store business will be accompanied by an unwanted margin pressure. Hence, store consolidation is a way of reducing costs, as Gap Inc would have to shed less money on their operating expenses and leases, and it can simultaneously spend more on its online channel to ensure uninterrupted growth. 

Our price estimate for Gap Inc is at $47, implying a premium of about 20% to the market price.

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See our complete analysis for Gap Inc.

Store Count For Gap & Old Navy Has Come Down Gradually

The physical store retailing model has almost run its course and the future of apparel retailing in the U.S. is online and omni-channel, which does not require a vast network of stores. Instead, the effective implementation of an omni-channel model requires an optimum presence in the country, which appears to be somewhere around 800, looking at different retailers’ consolidation strategies. Hence, Gap Inc is looking to lower the store count of its main brands in the U.S. to be part of this industry-wide shift in the operating model. The retailer lowered Gap’s North America store count by 233 between 2008 and 2014 and Old Navy’s store count was down 54 in the same period.

Gap store countold navy store

Meanwhile, Revenue Per Store Has Gone Up

The main idea behind the store consolidation strategy was to improve productivity and profitability. Between 2009 and 2014, annual revenue generated per Gap store and Old Navy store has increased at a compound annual growth rate (CAGR) of 3.9% and 2.1%, respectively. This clearly indicates that Gap Inc has closed stores that did not contribute much to overall revenues, though simultaneous growth in web revenues is also responsible for the rise.

gapold navy

The marginal decline in Gap’s revenue per store in 2014 is due to weak traffic in its stores last year, on account of lack of fashion comparable with fast-fashion companies such as Zara and Forever 21. For Old Navy, although the revenue per store trend has been a little wayward, it is up significantly since 2009 due both to the closure of weaker stores and a rise in online revenues.

Expenses Per Store Have Been Under Control

Gap Inc’s annual operating expenses per store have fluctuated over the past six years, but they have been down steadily since 2012. The company has surprisingly kept its expenses under control, despite the expansion of online channel that accounts for additional expenses. Gap Inc has managed to do so by identifying and closing stores that did not generate enough revenues but had significant operating expenses. The illustration below shows how the company’s overall operating expenses (excluding COGS) per store have trended over the past six years.

operating expenses

Operating expenses per store peaked in 2012 due to a significant rise in Gap brand marketing, customer relation marketing, store payroll and higher bonus expenses. The company, however, has managed its expenses very well thereafter, which would have partially benefited from the closure of inefficient stores.

Operating Income Per Store Has Increased

With the rise in revenue per store and a relatively weaker increase in operating expenses, operating income per store for Gap and Old Navy has increased. Although there hasn’t been a clear increasing trend in operating income for either of the brands, they have increased at a CAGR of 3.7% and 1.9%, respectively, since 2009. The graphs below show a clear dip in operating income in 2011, which is attributable to a sudden fall in gross margins during the year. In 2011, cotton prices had shot up drastically due to floods in major cotton producing areas that hampered supply considerably. Other than 2011, operating income trend for both the brands appears consistent.

gap operating incomeold navy operating income

Overall, the above graphs show us that Gap and Old Navy stores are getting more productive and profitable, albeit at a slow pace. Although store consolidation may not be solely responsible for this improvement, it has certainly played a crucial role. This clearly indicates that store consolidation isn’t just about repositioning store fleet in line with the omni-channel platform. It works in more ways than one.

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