Gap: CEO Appointment Is Positive, but Old Navy and Other Challenges Await; Shares Very Undervalued

No-moat Gap GPS has named Richard Dickson, president and chief operating officer at narrow-moat Mattel, as its CEO. Gap has been without a permanent CEO for an entire year, having been led on an interim basis by Bob Martin, who remains as chairman. Dickson was credited with revitalizing Barbie, Hot Wheels, and other brands at Mattel and has apparel industry experience at multi-brand owner The Jones Group and upscale department store Bloomingdale’s. At Gap, he will face serious challenges, including recent underperformance at Old Navy and Athleta, and the chronic search for relevance at Gap Global and Banana Republic. Realistically, Gap has struggled to find consistency since former CEO Mickey Drexler was fired more than 20 years ago.

We do not think Gap’s current share price, well below our $23.50 fair value estimate, reflects its opportunities for profit growth. To his credit, Martin has not been standing still, having brought in several new leaders, improved Gap’s inventory, and cut costs. We forecast improving, although modest, profitability in 2023′s second half. In the medium term, we think Gap can lift its operating margins from less than 3% in 2023 (expected) to 7.5% in 2027 as Gap Global and Banana Republic are downsized and higher-margin Athleta and Old Navy become larger.

We do not anticipate any significant changes in Gap’s capital allocation under Dickson and are maintaining our Standard rating. Despite its weak earnings, we forecast the firm will generate sufficient free cash flow to continue to fund its $0.15 per share quarterly dividend (6% current yield). However, we do think it will hold off on further share repurchases until its earnings improve in 2025.