Gap Stock Up 14% YTD, Time To Buy?

Gap Inc. stock (NYSE: GPS), a specialty retailer selling casual apparel, accessories, and personal care products for men, women, and children under the Gap, Old Navy, Banana Republic brands, became vulnerable during the pandemic due to its nonessential product assortment. While Gap’s stock figure slid sharply during the early months of the pandemic, it has recovered from the March lows of $6 and are now 14% higher than the beginning of the year. So, is it a good time to enter the stock at around $20? We think not. The retailer’s stock has lost around 23% in the last one month, due to an earnings miss in Q3 despite improved results, and we believe that the stock is now appropriately valued at the current price for the near term.

This is taking into account Gap’s revenues which have declined 20% year-over-year (y-o-y) so far. Also, the apparel retailer’s revenue declined marginally in fiscal 2019, as compared to a 4% growth in the previous year. The Gap GPS brand has failed to resonate with customers for years, and this division accounts for a large 25% of total sales. To add to this, store closures may only provide some margin relief in the near term, but they don’t represent a permanent solution. Also, increased digital business will likely continue to weigh on its profitability. All this indicates that the retailer could likely get back to its slower pace of growth once the Covid threat abates. Our dashboard,What Factors Drove 40% Decline in Gap Inc. Stock Between 2017 And Now? provides the key numbers behind our thinking, and we explain more below.

Gap’s stock price declined around 48% from $34 in fiscal 2017 to close to $18 in fiscal 2019. Obviously, the company’s stock hasn’t been a great investment over the past three years as its styles have fallen out of favor. The company saw a 3% increase in revenues during this period, driven by solid results from the Old Navy brand and high growth from the Athleta women’s activewear brand, offset by weak progress from both The Gap and Banana Republic chains (which were the height of popular fashion in their heydays).

Finally, Gap’s P/S multiple has declined from 0.8x in fiscal 2017 to 0.4x in 2019. While the company’s P/S has now increased to 0.5x, it seems to be fairly valued, given the volatility of the current situation.

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In the company’s fiscal third quarter, which ended on Oct. 31, net sales were flat year-over-year (y-o-y), and comps were up 5%. The highlight was digital sales increasing 61% y-o-y, offsetting a 20% drop in-store sales. In fact, its online channel had 3.4 million new customers, a 145% increase over the prior year, which also made 40% of its total sales mix. As usual, Old Navy and Athleta brands posted the company’s best performances, growing by 17% and 35%, respectively. However, Banana Republic’s sales fell 30% and The Gap brand’s sales declined 5%. To add to this, higher shipping costs, elevated marketing spend, and pandemic-related costs continued to weigh on the company’s profitability.

Going forward, Gap expects sales to be equal to or slightly higher than last year in Q4. Higher shipping costs will fully offset the benefit from store closures, keeping gross margin roughly flat. In addition, operating expenses are also expected to range between 33% to 34% of sales (compared to just 30.3% of sales in the year-ago period). Overall, the company guidance inclines toward a decline in earnings again.

At Gap’s investor day, management set a goal of growing Old Navy’s annual sales to $10 billion and Athleta’s annual sales to $2 billion by fiscal 2023. If these brands hit their growth targets, they’ll account for about 70% of Gap’s sales by 2023, up from 55% last year. Although the company seems to have taken steps in the right direction, everything will hinge on its ability to maintain its sales levels post-Covid. For now, there are too many potential stumbling blocks.

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