Gap Inc: Why A Slow 2015 Can Pave The Way For A Better 2016

The year 2015   so far has been weak for apparel major retailer Gap Inc (NYSE:GPS), and the holiday quarter is unlikely to be any better. This can be attributed to the fact that the retailer has spent a major part of the year trying to re-establish its mainline brands — Gap and Banana Republic. Through the year, the retailer has been clearing its old inventory to make way for the updated merchandise portfolio scheduled to hit its stores during the spring season next year. These short term headwinds are why Gap Inc’s performance has been below par this year. The company knows very well what its customers want and is working proactively to deliver on that. Thus we believe that a year spent with heavy markdowns on old merchandise was a small price to pay to ensure better customer response for next year and beyond.

When the apparel industry started struggling with a pullback in consumer spending, a change in spending patterns and the growth in fast-fashion brands’ popularity, Gap Inc remained resilient for a while. However, its premium mainline brands ultimately fell behind as they were unable to compete with relatively cheaper merchandise from Zara, Forever 21 and H&M. Ever since, the retailer has been trying hard to revamp Gap and Banana Republic by infusing them with more and Old Navy’s successful strategies.

Our price estimate for Gap Inc stands at $43, which implies a significant premium to the current market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Gap Inc.

This is the era of fast fashion retailing. Buyers across the market are buying cheaper fashion-forward clothes more frequently, a trend that has been set into motion by fast fashion companies such as Zara, Forever 21 and H&M. These companies are beating a number of casual apparel companies on prices and they have been turning their inventory over at a much faster rate. As a result, they have become the primary shopping destination for a number of shoppers, who are now less frequently patronizing relatively expensive and less diverse brands such as Gap and Banana Republic.

In response, Gap Inc is aggressively working towards improving its merchandise design and back end supply chain infrastructure. CEO Art Peck mentioned a while back that the merchandising team has made significant progress on different facets of the brands and they are focused on implementing a new operating model to improve demand forecast and speed-to-market. While this transition has had a negative impact on Gap Inc’s 2015 performance, it is expected the strengthen the core of the companies brand portfolio going forward. For improving its premium brands, the company is looking to leverage Old Navy’s successful flexible manufacturing system, wherein certain products are launched in small batches to test demand, before beginning the mass production. The management has even spent a lot of time with customer reviews, to identify which of the existing products they can keep in Gap and Banana Republic’s portfolio, when their updated version is launched.

Gap Inc is one of the biggest apparel retailer in the U.S. and has a history of delivering on buyers preferences. Though the industry landscape has changed much over the past couple of years and the retailer has been a little slow in adapting to this change, it is moving in the right direction nonetheless. Gap and Banana Republic’s disastrous performance during the three quarters of 2015 do not indicate the weakness in these brands’ core. In fact, considering the aforementioned reasons, we regard them as latent signs of an imminent recovery.

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