After Sprinting 170%, Gap’s Stock Needs A Rest

Following a 170% rise since the March 23 lows of this year, at the current price of around $17 per share we believe Gap stock (NYSE: GPS) has reached its near term potential. Gap’s stock has rallied from $6 to $17 off the recent bottom compared to the S&P which moved 48% over the same time period. Gradual store re-openings, as well as Gap’s deal with Kanye West’s Yeezy brand to introduce a new clothing line, Yeezy Gap, has helped the stock in beating the overall market. However, Gap’s stock is down 46% from levels seen in early 2018, over two years ago. While the company’s stock has recovered and is similar to the figure it was at in February before the drop due to the coronavirus outbreak becoming a pandemic, the stock seems to be fairly valued as of now. Our dashboard ‘Why Gap Stock moved -46%?’ provides the key numbers behind our thinking, and we explain more below.

Some of the stock price decline over the last 2 years is justified by the roughly 60% fall seen in Gap’s net income margin from 5.3% in 2017 to 2.1% in 2019. This decline was partially offset by a 4.3% reduction in share count due to stock repurchases worth $600 million made over the same time period. Overall, Gap’s earnings per share basis plunged by nearly 57%, which led to a decline in the company’s stock price. Notably, though, the company’s revenues have seen a marginal 3.3% growth between 2017 and 2019.

Finally, Gap’s P/E multiple grew from 14x at the end of 2017 to nearly 19x at the end of 2019. While the company’s P/E has now declined to around 18x, it seems to be fairly valued when the current P/E is compared to levels seen in the past years. P/E of 19x at the end of 2019 and 14x as recent as late 2017. We believe the stock is appropriately priced and Gap’s multiple looks appropriate when compared to levels seen over the recent years, and the stock is unlikely to see significant upside after the recent rally and the potential weakness from a recession-driven by the Covid outbreak.

How Is Coronavirus Impacting Gap’s Stock?

The Coronavirus crisis has hit the apparel industry hard. Fading consumer demand, reduced discretionary spending, and stay-at-home orders resulting in stores remaining closed continue to take their toll on the apparel industry. The effects of Covid-19 were clearly evident in the company’s Q2 2020 (ending July) earnings, with the company’s revenues falling by 18% y-o-y to $3.2 billion. However, the company has two of the most recognized brands in the apparel industry in the name of Athleta and Old Navy. Gap’s brand appeal and a diversified geographical business should help the company’s revenue to recover. Furthermore, the company’s stores have re-opened which should provide a boost to the company’s revenues as mall traffic returns to normal, given that Gap has one of the largest retail footprints. Despite the recent store openings, Gap’s revenues are likely to remain suppressed for at least a couple more quarters, making the stock fully valued at its current levels.

However, over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus, which set a floor on fear, the market has been willing to “look through” the current weak period and take a longer-term view,  with investors now mainly focusing their attention on 2021 results.

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