Shares of clothing retailer the GAP (GAP) have perked up recently, but generally remain rangebound. I believe there’s an image problem here as many investors view the company as stale. Nonetheless, Gap delivers consistent results, has seen margin gains, and is participating in exciting new fashion trends. For these reasons, I rate GAP stock a Buy.
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Gap’s History
The name “Gap” evokes nostalgia for many people. For millennials, Gap is probably considered a brand their parents liked. For anyone else, search “GAP Swing Commercial 1998”, and you’ll be transported back in time. The Gap, and especially its line-up of khaki pants, was all the rage 25 years ago. That marketing campaign and much of the Gap’s fashion lineup was itself a throwback to the pre-rock, pre-denim era.
The Gap was incorporated in 1969. In 1993 the then CEO pursued a spin-out initiative for a lower-priced clothing chain. This was originally called Gap Warehouse, but was soon renamed Old Navy. The Old Navy brand remains a value apparel chain to this day, and is truly the flagbearer for the company. In 2023, Old Navy represented 55% of total sales at the company, and within the U.S. approximately 3 times the sales of branded Gap stores. A decade ago, revenue from Gap exceeded that of Old Navy.
Fast fashion and value apparel have been leading trends lately, and management of Gap have responded by shrinking the number of store locations in the U.S. by about 50%. Old Navy’s store count, by contrast, has increased. Smaller brands Banana Republic and Athleta represent about 13% and 9% of company-wide sales, respectively. Athleta is Gap’s athletic apparel brand that competes against Lululemon Athletica (LULU).
Business Trends and Challenges
Most financial websites display up to 10 years of financials for a given company, but that would omit a key part of Gap’s story. Over the past 20 years annual sales have been straddling the $15 billion level. One of Gap’s biggest challenges has been aging demographics. The chain’s under-35 target consumer group that it charmed a few decades ago are now the under-60 group, and probably only enter a Gap store with their kids. Meanwhile upcoming generations of shoppers haven’t engaged with Gap as strongly, and trends have changed.
However, one thing I really like about Gap as a company, and a key reason I’m bullish on the stock, is that it has its fingers in four pies. Any attempt to adjust to changing fashion trends within a single brand risks potentially alienating current clientele. With four store chains under its umbrella, Gap can be more patient, in my opinion, and that seems like an asset for the company.
While many shoppers might find pricing or styles at Gap-branded stores unappealing, the company has simply reduced its reliance and footprint of these stores in favor of Old Navy outlets. In 2022, it was Banana Republic that posted the only same-store sales growth for the company. If one brand is out of favor, another may be positioned to pick up the slack.
Gap’s Steady Financials
It’s easier for management to be patient when the company is posting steady financials. Except for some periods during the pandemic, Gap has been consistently profitable. Also, while sales growth has wavered, the company has been posting impressive margin gains is recent years. Gross margin reached 68% in the last holiday quarter, while all other quarters since mid-2023 have realized margins above 40%.
The company’s earnings per share (EPS) have shown an increasing trend of growth, and beaten analyst consensus estimates for the past seven quarters. It’s possible that analysts have been lowballing their estimates and that may be the case for the upcoming fourth quarter as well, where the consensus Wall Street EPS target is just $0.35, which would be down from $0.49 last year.
On a cashflow basis, GAP’s free cash flow has been well north of $1 billion, and that’s against a current market cap of $9.8 billion. The company’s price-to-cashflow of around 6.25 times is well below its retail peers. And shares look attractive at a 13 times price-to-earnings (P/E) multiple based on a Fiscal year 2024 EPS estimate of $2.
Is GAP Stock a Buy?
Analysts have a consensus Moderate Buy rating on GAP stock according to TipRanks. Of the 14 analysts who cover the stock, there are currently seven Buy, six Hold, and one Sell ratings on the stock. The average GAP stock price target of $28.15 implies 8.27% upside from current levels.
Conclusion
Legacy GAP shoppers are not likely to return as customers to those stores, and with many fashion labels that have had moments of infamy it’s easy to be pigeonholed as passé. But, with a fresh leadership team at the helm, there’s still an opportunity that Gap will capture the excitement of a new generation. In the meantime, the company can continue to rely on its assortment of brands and its strong financials. For these reasons, I remain bullish on GAP stock.
