Does Gap Inc Have Enough Cash To Survive Covid-19 Demand Shock?

With most retail stores shut and people holding off on discretionary spending, chains such as  Gap Inc (NYSE:GPS) may be looking at an existential crisis – a big change from typical growth issues they tackle every day. The company’s stock has fallen 50% this year reflecting the demand shock that may push it into a liquidity crisis. How vulnerable is Gap Inc? Our dashboard Does Gap Inc Have Enough Liquidity To Survive Covid-19 Demand Shock examines the company’s cash flow generation ability, resilience of cost structure and operational runway, and compares it to that of its peers. You’ll be surprised to know that Gap has very little room for absorbing demand shock and can take just -9% revenue decline before its operating income falls to break even level (zero). In addition, we find that in a likely scenario where demand takes until Q4 to bounce back and annual revenue declines by 30%, Gap Inc will lose more than $150 million in cash. While it has the cash balance to support this outflow, it barely has 4 months of runway if the demand falls to zero. Needless to say, the next few months will be critical.

How Much Revenue Hit Can Gap Inc Take Before It Starts Losing Money? 

In 2019, Gap Inc posted net income of $351 million on revenue of $16 billion. We estimate that variable operating expenses, which include cost of merchandise, shipping and packaging charges, direct payroll costs etc, were $10.25 billion, representing 65% of total operating expenses. Based on this we calculate that variable operating expenses represent 63% of revenues and determine that operating income will decline to the break-even point (no profit no loss) if 2020 revenue falls by -9% vs 2019. In comparison, the break even revenue figure for Limited Brands stands at around -6%, while that for Steve Madden and Foot Locker Inc stands at -26% and -23% respectively. Clearly, Gap Inc is at a risky position vs some of the other fashion brand retailers. However, even at break-even operating income, Gap will face losses as it will need to cover interest expense even if we assume taxes to be zero. As of the beginning of February, Gap had outstanding debt of $1.25 billion excluding operating lease liabilities that have been capitalized.

Will Gap Inc Survive If It Takes Until Q4 For Demand To Bounce Back? 

Consider a case where the demand slump created by the pandemic fades by Q4 2020 and all Gap Inc stores are opened for business in a phased manner. In this scenario, we assume an annual drop of 30% in revenue and a 50% capital expenditure cut reflecting fiscal discipline. A significant portion of the capex cut can come from store closures which can reduce maintenance capex. We also assume that Gap Inc will not spend any cash on share repurchases. In this case, Gap will likely report losses of -$872 million on revenue of $11 billion, and face cash outflow of $-163 million after covering capital expenditures. How will it fund it? As of beginning of February, Gap had a cash balance of $1.36 billion, which is enough to cover this outflow. In addition, it also raised $2.25 billion in new capital in the last week of April 2020, out of which $1.75 billion is to repay existing debt and $0.5 billion is incremental.

However, the above assumes that Gap Inc can survive Q2/Q3 when there is likely to be very little demand. This is where it gets risky. How much runway does the company have if consumers stop purchases altogether?

Extreme Stress Test: Gap Inc Has Just 3.6 Months Of Runway In Case Of No Demand

Here is another way to understand Gap Inc’s resilience. How much operational runway does Gap Inc have if there is no demand and revenue remains zero? As it turns out, it has just 3.6 months of runway, not counting the recent debt it has raised. That’s not good news considering the demand slump and uncertainty around the Covid-19 spread. The next few months are going to be critical.

The apparel industry is not the only one feeling the pressure. General retail chains such as Macy’s are also in vulnerable situation. See whether Macy’s is better structured than Gap Inc to survive demand slump.

See all Trefis Price Estimates and Download Trefis Data here

What’s behind Trefis? See How It’s Powering New Collaboration and What-Ifs For CFOs and Finance Teams | Product, R&D, and Marketing Teams