VALUATION HIGHLIGHTS

1. Old Navy Stores constitute 53% of the Trefis price estimate for Gap Inc.'s stock.
2. Gap Stores constitute 20% of the Trefis price estimate for Gap Inc.'s stock.
3. Banana Republic Stores constitute 13% of the Trefis price estimate for Gap Inc.'s stock.

WHAT HAS CHANGED?

1. Gap Tops Q3 Estimates
   • Gap's comparable sales rose 1%, surpassing a bearish Wall Street estimate set at -3.44%. Overall revenue increased by 2% to $4.04 billion, beating expectations of $3.8 billion. Store rationalization efforts seemed to pay off at Gap brand and Banana Republic stores, where comparable sales rose 4% and 10%, respectively. At Old Navy, which makes up roughly half of the company's revenue, comps were down 1% and they were flat at Athleta.
   • It should be noted that the retailer's adjusted gross margin, which excludes a $53 million impairment charge related to the termination of Gap's relationship with Kanye West, fell 320 basis points to 38.7% due to higher discounting and elevated commodity input prices. However, the company made up for that with new cost-cutting efforts targeting $250 million in annual cost savings. As a result, adjusted operating expenses fell by 280 basis points as a percentage of revenue to 34.8%.
   • On the bottom line, the company reported adjusted earnings per share of $0.71, up from $0.27 a year ago and much better than estimates at breakeven. Without a $0.33 per share tax benefit, adjusted EPS would have been $0.38.

Note: Gap's FY'21 ended on January 29, 2022. Q3 FY'22 refers to the quarter that ended on October 29, 2022.

2. Weak Q4 guidance

The company expects trends to deteriorate in the holiday quarter, forecasting a revenue decline of mid-single-digits, which compares to the analyst consensus calling for a decline of just 0.6%. Gap did expect to get a boost on the cost side, calling for a 540 basis point lift in gross margin as it laps additional air freight charges from last year, though it said inflation would add 200 basis points in expenses.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

BUSINESS SUMMARY

Gap is a global specialty retailer offering clothing, accessories, and personal care products for men, women, and children. It markets its products under the Gap, Old Navy, Banana Republic, Athleta, GapKids, babyGap, and Intermix brands.

Gap operates stores in North America and several countries in Europe and Asia. It is one of the few U.S. apparel retailers that have a decent international presence. The company also sells its products online through web-based stores for each of its brands. The company has recently changed its reporting structure due to its adoption of omnichannel retailing. It no longer reports separate e-commerce revenues but includes them in individual brands' revenues. In addition to this, Gap has franchise agreements with unaffiliated franchisees to operate Gap, Old Navy, and Banana Republic stores in many countries.

The retailer operates three different brands for three main demographics: Old Navy for cost and fashion-conscious teenagers, Gap for young adults, and Banana Republic for more affluent and relatively older customers.

KEY TRENDS

Development of omni-channel platform

An omnichannel platform enables retailers to engage customers irrespective of the shopping channel they prefer. Gap Inc. launched its ship-from-store service, which allows the fulfillment of online orders through store inventories. This service enables the company to offer a greater variety of merchandise over the Internet but also helps it improve delivery responsiveness and store traffic. The company also 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.

Online retail sales in the U.S. have grown at a rapid pace over the past several years, thanks to growing internet usage in the country. Internet penetration in the U.S. increased from 89% in 2020 to 92% in 2021. Furthermore, facilitated by the convenience of constant access, 92% of teens today go online daily, including 24% who are online constantly, according to a study conducted by Pew Research Center. Over half of the teens (aged 13 to 17 years) go online several times a day, aided by the presence of smartphones, which are available to nearly three-quarters of teens. Smartphone usage will only increase in the future, and this will likely result in a steady rise in online sales.

Efforts to gain market share in the U.S.

While Gap Inc. is consolidating its main brand networks in North America, it is looking at other ways to gain a share in the U.S. apparel market. The retailer is relying on smaller brands for this purpose, such as Athleta, Intermix, GapKids, and babyGap, to grow its business in North America. Through Athleta, Gap Inc. offers performance-driven sports apparel and footwear for women. In line with its growth strategy detailed during FY 2019, the company expects store openings to be focused on Athleta and Old Navy, with closures weighted toward Gap and the Banana Republic.

Optimizing Store Fleet

Gap Inc. has continued the process of optimizing its store count, including reducing its exposure to low-productivity stores. The company has also seen an opportunity for increasing the store count of Athleta, Old Navy, and the factory and outlet expressions at the Banana Republic and Gap. Consequently, in FY 2021, the company saw net openings of 32 Old Navy stores and 28 Athleta stores and continued to close under-performing Gap and Banana Republic stores in North America.