Gap Inc (NYSE:GPS) is one of the few apparel retailers in the U.S. that has performed well even in unfavorable market conditions. Backed by its strong market position, growing e-commerce channel and fashion blog marketing, the company registered sturdy growth during the weak holiday season and cold affected first quarter. Its momentum continued in the second quarter as well when most apparel retailers were struggling to match their previous year’s performance.
However, based on reported sales data, we know that the retailer post slower growth will slow down when it comes out with its Q3 fiscal 2013 earnings release on November 21. Despite its strong growth fundamentals, Gap Inc’s comparable store sales increased by just 1% in in the third quarter.  While strong product offerings and the e-commerce channel supported the company’s growth, industry-wide weak apparel sales had an offsetting impact. In terms of individual brands, Gap alone posted positive growth while Banana Republic registered negative growth and Old Navy remained flat. Nevertheless, the retailer is still performing better than its peers Aeropostale (NYSE:ARO) and American Eagle Outfitters (NYSE:AEO).
Our price estimate for Gap Inc. at $50 implies a premium of about 20% to the market price.
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Strong Product Offerings Helped In Attracting Customers
Gap Inc has been on top of changing fashion trends, which has allowed it to attract customers with appealing products. Last year, it did a complete overhaul of its top level management and appointed separate heads for different divisions and brands to specifically focus on their individual needs.  The company’s strong inventory control has also helped it remain responsive to changing fashion trends for different seasons. The retailer operates a flexible supply chain with over 1,000 vendors located in 40 countries. None of them account for more than 5% of the goods. Moreover, about 98% of the inventory is sourced from outside the U.S., which helps it offer good products at competitive prices. 
During the last quarter, Gap Inc’s core products such as denims and woven tops, along with its seasonal offerings such as summer dresses and shorts, delivered good performance. The company’s youngest brand, Old Navy, was the strongest during the quarter with healthy growth coming from kids & baby products, summer collections, flip-flops, active shorts and dresses. For Banana Republic, categories such as suitings, pants, and woven tops were among the strongest growth drivers. ((Gap Inc.’s May earnings transcript, Jun 6 2013))  In July, Old Navy launched a vintage tee collection under the tag “Mickey Through The Decades” featuring Disney’s most iconic character – Mickey Mouse. The collection included t-shirts for all age groups depicting Mickey Mouse’s evolution over the years.  The appealing product, combined with attractive pricing, supported the brand’s growth to some extent. Moreover, Banana Republic was selected as formal attire supplier for ORACLE TEAM USA, the sailboat racing syndicate and current defender of the 34th America’s cup. 
For the back-to-school season, Gap Inc launched a number of products for kids such as skinny jeans, a uniform ruffle shirt, bootcut pants, capri pants, a jumper, and neon pleated skirts, among others. The company also launched a global marketing campaign called “Back To Blue” during August to further solidify its brand image. The campaign featured celebration of the brand’s heritage through different channels such as print, outdoor, direct, social, in-store, digital and television.  We believe that these efforts helped the company to attract customers and generate higher revenues.
Direct-To-Consumer Channel Is Supporting The Revenue Growth
The 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 revenue has increased by more than 60% over the past two years and it further jumped 27% during the first two quarters of fiscal 2013, despite a difficult retail environment.
Apart from the industry growth, Gap Inc’s mobile apps and mobile-optimized websites have played a vital role in strengthening its Direct-to-Consumer business. Additionally, its ship-from-stores services, which allows the fulfilling of online orders through store inventories, have enabled it to offer a greater variety over the Internet, maintain delivery responsiveness and drive store traffic. Since the retailer’s merchandise offerings remained strong during the third quarter, we expect the strong growth in e-commerce channel to continue.
However, Weak Apparel Industry Had A Negative Impact
This year, the U.S. apparel retail market has been particularly weak due to cautious consumer spending and a change in spending patterns. Hit by the impact of the payroll tax increase, slow job growth, gasoline price increases and higher healthcare costs, U.S. buyers have been extremely watchful of their spending on discretionary products. Moreover, some buyers have started diverting their spending to cars and houses to take advantage of the low interest rates. Accordingly, they are holding back on other products such as apparel and accessories. This resulted in a weak back-to-school season for apparel retailers.
As a result, U.S. retailers relied on deep discounts to win back customers, which weighed heavily on their growth. According to the Commerce Department, retail sales in August (excluding the automotive sector) increased by just 0.1%. In September, Gap Inc stumbled on the industry weakness as it posted a decline in comparable store sales. The government shutdown in October slowed the job growth and weighed on consumer confidence. Due to this, U.S. retailers reported only modest growth during the month.  As a result, Gap Inc managed to register just 1% increase in its comparable store sales. Its relatively expensive brand Banana Republic posted negative growth. We await management’s commentary and the additional details it will provide with the release.Notes:
- Gap Inc. Reports October and Third Quarter Sales Results, Gap Inc, Nov 7 2013 [↩]
- Gap revenue beats as same-store-sales rise 5%, CNBC, Aug 22 2013 [↩]
- Gap Inc’s SEC filings [↩]
- Gap Inc.’s June earnings transcript, Jul 11 2013 [↩]
- Old Navy Launches “Mickey Through The Decades” Vintage Tee Collection, Gap Inc., Jul 8 2013 [↩]
- Banana Republic Chosen As Formal Attire Supplier Of ORACLE TEAM USA, Defenders Of The 34′th America’s Cup, Gap Inc., Jul 9 2013 [↩]
- Gap Gets “Back To Blue”, Gap Inc., Aug 12 2013 [↩]
- U.S. retailers’ October sales rise, but holiday concerns remain, Reuters, Nov 7 2013 [↩]