Good News, Bad News for Gap
Same-store sales continue to rise at Old Navy and decline at Gap.
As no-moat Gap (GPS) has pivoted its brand building efforts toward segments that resonate with consumers (Old Navy and Athleta), the firm has been able to bolt on its seventh consecutive quarter of comp store sales gains (at 2%). However, while Old Navy (48% of total sales) has linked together nine quarters of positive same-store comp growth, Gap (30% of sales) has continued to languish, with the last eight quarters delivering comp store declines. Despite comps that were 2% better than our forecast at both Banana Republic (2%) and Old Navy (5%), we don't plan any change to our back half comp outlook, as the firm has maintained its flat to slightly up comp outlook for 2018, which is near our 1% estimate. Furthermore, with reiterated 2018 earnings per share guidance of $2.55-$2.70 (versus our $2.61 outlook) despite the slight outperformance, sales and EPS growth could slow modestly from their second quarter cadence, supporting our thesis that competition remains robust (although Gap is lapping high-single-digit revenue growth in the final quarter of 2017). In this vein, we plan to maintain our $33 fair value estimate and view the shares as fairly valued.
We think Gap will continue to lose share to fast-fashion and off-price peers, with no clear execution on a plan to stave off losses we are currently seeing in key segments (Old Navy and Banana Republic continue to grow slower than the clothing and accessories market). As a result, we model same-store sales to be 1% on average annually over the next five years, below our expectation for 3% average annual retail sales growth. Given plans to offset the closure of Gap and Banana Republic specialty stores over the next few years with the opening of Old Navy, Athleta, and value-oriented stores, we see store growth as roughly flat over the next five years. With cost savings and improved inventory levels (likely leading to lower discount levels), we see operating margin stabilizing around 9%, in line with fiscal 2017 levels.
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Jaime M. Katz, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.