Old Navy To Again Be The Saving Grace For Gap Inc.

by Trefis Team
Gap Inc.
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The apparel retail industry has been plagued with soft mall traffic and reduced consumer spending, which has resulted in a spate of downsizing and bankruptcies. Gap Inc. (NYSE:GPS), being a part of this blighted sector, has been suffering as a result. However, in its first quarter earnings release, it reported an improvement in its earnings per share and a largely flat sales growth, both metrics which beat consensus estimates, bucking the trend of dismal results in the retail industry. Even in the second quarter, the company was able to surpass expectations, although it underwent a decline in its sales and earnings. This time around, a 1% fall in revenues is expected along with an EPS of $0.54. Weak sales in the past had forced the company to resort to markdowns which pressured margins. Could the company fall back into that vicious cycle if the sales remain low? That is the biggest question facing the company this earnings season, in a highly pivotal quarter.

We have a $25 price estimate for Gap Inc., which is 6% lower than the current market price.

Shift In Strategy For Long-Term Success

Gap recently outlined its strategy to ensure balanced growth in the years to come. The company will continue to focus on its growth brands, such as Old Navy and Athleta, while closing down about 10% of its Gap and Banana Republic stores from “lower productivity” locations. This move follows from the decline in demand for the company’s more established brands, in favor of its younger chains. Gap, in general, has suffered from a decline in store traffic, a factor that has been plaguing many teen apparel companies, which are mostly located in struggling enclosed malls. The company will instead focus on areas where the customers are actually shopping- off-price locations and online.

Such a change in strategy is a tacit acknowledgment of the company’s inability to turn around the fortunes of its namesake and Banana Republic brands. The former’s comparable sales have not increased in 14 quarters, while the latter has posted 10 straight quarters of falling comps, including a few double-digit declines. This poor performance has occurred regardless of the fact that the company has undertaken various initiatives to spur their growth, and has even closed down a number of underperforming stores.

Old Navy And Athleta To Be The Key Focus Areas

Old Navy, on the other hand, has been a saving grace for the company. Being a lower-priced brand will stand them in good stead and continue in the future. While the brand hit $6.8 billion in sales in the last financial year, the company’s growth target of achieving $10 billion in revenues in the next few years may seem a bit ambitious. According to our estimates, Old Navy will reach almost $8 billion in revenues by 2024. The brand started its tremendous performance under the three year reign of Stefan Larsson, who stepped down from his position in 2015 to lead Ralph Lauren. Though the brand did falter a bit on his departure, it regained its footing subsequently, with Old Navy becoming the fastest growing apparel brand in the US.

Another key growth area for Gap in the future will be its activewear brand Athleta. The US activewear market is a $40 billion behemoth, with an 8% average annual growth rate, representing one of the highest growth areas in the apparel market. Gap’s Athleta brand is solely focused on this space, while the company provides athletic wear in its other segments as well. For the company as a whole, the athletic wear segment contributes over $1 billion in revenues, through Athleta and its other segments, and at the end of the second quarter of FY 2017, the company had garnered 3.5% share in this growing market, a 20 basis points improvement. The popularity of the company’s products will result in scale, and consequently improved margins. Athleta has grown at 25% every year since 2012, outpacing the growth in the overall athleisure market, and in the future, the company expects to attain revenues of $1 billion through this brand alone. This will be driven by growth in the online and mobile channels, as well as through market share improvement and store expansion.

See our complete analysis for Gap Inc.

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1) The purpose of these analyses is to help readers focus on a few important things. We hope such communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Gap Inc.
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