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Stock Strategist

Undervalued Retailer Closes Gap With Competitors

Gap's investments in supply-chain responsiveness and omnichannel capabilities could lead to rapid margin expansion.

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With investor attention focused on what we perceive to be near-term, fixable product issues within the core  Gap (GPS) brand, we think Gap's larger and more important margin expansion story is being overlooked. Having invested heavily in a seamless inventory model (expected to be fully integrated by 2016), omnichannel capabilities, including ship from store, find in store, reserve in store, and order in store, and responsive supply chain initiatives, including fabric platforming, vendor-managed inventory, rapid response, and test and respond, Gap is poised to close the disparity between its low-double-digit operating margin and the high-teens margins of fast-fashion competitors including  H&M (HM B) and  Inditex (ITX), in our opinion.

These initiatives reduce lead times and allow the company to read demand and react to the color, size, or silhouette that customers are purchasing. In total, these initiatives should reduce volatility in performance, increase full-price sell-through, and fulfill previously missed sales, putting Gap well on track to matching fast-fashion core competencies. The company expects to increase the percentage of assortment on the responsive model to 50% by the end of 2016. If it is successful, we see no reason Gap could not only reduce the operating margin gap between itself and other fast-fashion retailers, but also further distance itself from no-moat companies. The stock is currently trading at a discount to our fair value estimate as a result of product challenges and an underappreciation of the margin expansion opportunity, and we believe this is an attractive entry point for investment.

Bridget Weishaar does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.