Gap's Moat Is Gone
We no longer think the iconic brand holds enough pricing power for a competitive advantage.
We no longer think brand strength can deliver pricing power for Gap (GPS), and we don’t believe the company will obtain its targeted cost advantages; therefore, we have lowered our economic moat rating to none from narrow. We also have reduced our fair value estimate to $22 per share from $38 to reflect our belief that management’s failure to institute a responsive supply chain will result in continued market share losses and limited possibility of margin recovery. We now assume revenue will decline 1% on average annually over the next five years and operating margins will stay flat at the 2016 estimate of 8% as cost-cutting measures and a cyclical recovery offset deleveraging and continued discounting.
Although we believe pursuing a responsive supply chain was the right strategy to enhance its competitive advantage, Gap has failed in the execution. Evidence on multiple fronts points to this. Management originally targeted 50% of product to be on the responsive supply chain by the end of 2016 and positive comparable sales in the first quarter. Instead, by the first quarter, Old Navy president Stefan Larsson had left the company, Old Navy performance (highlighted as the goal of what a responsive supply chain could achieve) was faltering, and CEO Art Peck was referring to supply chain efforts as “a journey, not a destination.” Conversations with the company have led us to believe that a more reasonable expectation for lead times is nine months (versus the prior goal of around a three-month manufacturing process), which further stands to impede its recovery.
Bridget Weishaar does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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