Best Stocks Ideas in 2021: Betting on GAP Stock

Gap continues to grow online sales as it refines its digital marketing strategy and invests in data analytics. Because of its great performances it is now considered one of the best stocks to buy right now and listed on the popular site Best Stocks. The new DressingRoom’ virtual-reality application has attracted customers who prefer to shop online, while reducing the level of returned merchandise. The company is also strengthening its marketing with new partnerships, including agreements with Kanye est (for the forthcoming launch of an exclusive YEEZY Gap line) and with the Women’s Sports Foundation. In September, it also launched a new customer loyalty program that allows customers to earn and redeem rewards across all brands.

Recent Developments

Net sales were flat at $3.99 billion, but topped the consensus by $190 million, with comp sales up 5%, driven by double-digit growth at Old Navy and Athleta, which together accounted for 63% of 3Q sales. Online sales grew 61% and accounted for 40% of net sales, benefiting from increased digital marketing, while in-store sales declined 20%. Management said the company gained 3.5 million new online customers in 3Q and that ‘loyalists’ accounted for over 50% of sales.

The company has taken a range of steps to increase its financial flexibility during the pandemic. These include suspending rent payments for closed stores, laying off approximately 15% of Gap employees, temporarily cutting executive and board salaries, deferring dividends, and suspending additional FY21 dividend payments and share repurchases. It has also substantially reduced inventory purchases and cut planned capital expenditures by 50% for the year. In addition, it has issued two new $2.25 billion senior secured notes and secured a new $1.9 billion credit revolver, which replaced its previous unsecured revolver.

It also anticipates operating expenses of 33%-34% of sales, and capital expenditures of $375million (about 2% of sales), above its previous forecast of $300 million due to new digital technology and other investments. It expects capital expenditures to increase to 4%-5% of sales next year. Management expects low to mid-single-digit sales growth, and operating margin expansion in FY22. It is also targeting an operating margin of 10% and operating cash flow of 10% of sales by the end of FY23. It expects Old Navy and Athleta to together account for 70% of sales in FY23, up from 63% currently.

To address the impact of Chinese tariffs, the company has shifted some sourcing to suppliers outside of China. About 16% of its products are currently made in China, down from 21% last year. Although a substantial portion of its fabric supply also comes from China, management said that there has thus far been no meaningful disruption.

Earnings & Growth Analysis

The company reports results for the following segments: Old Navy (56% of 3Q sales), Gap (25%), Banana Republic (10%), Athleta (7%) and ‘Other’ (2%). Recent segment trends and outlooks are summarized below. 

In the Old Navy segment, 3Q net sales grew 15% to $2.2 billion, reflecting a decline in store sales offset by 86% growth in e-commerce sales. Comparable sales grew 17%. About 75% of Old Navy stores are located in off-mall strips, which continue to generate stronger sales than mall-based stores. Sales of active apparel remained strong, benefiting from increased demand for affordable casual clothing. The brand also benefited from growth in the U.S. Kids & Baby apparel in 3Q. Old Navy exited China in early 2020 in order to focus on better opportunities in North America as well as on digital investments. In FY20, Old Navy opened 73 new stores and closed five. In FY21, it opened 14 new stores and closed three. We expect fewer Old Navy store openings to limit growth going forward. We note that the Old Navy has created a chief creative officer position to address fashion and product assortment issues.

Gap Global posted a 14% decrease in overall sales in 3Q, with comp sales down 5%. Though store sales declined in the third quarter, online sales increased 38%. The brand has suffered from weak strategic positioning and marketing issues. Following the departure of president and CEO Neil Fiske in January 2020, Mark

Breitbard was appointed to oversee the transformation of the brand, which is focusing on driving online traffic through improved marketing, stronger execution, and increased customer engagement. In June, the company announced a partnership with Kanye West to develop an exclusive YEEZY Gap line, which will  launch next year. Within the GAP brand, prior to the pandemic, the online business accounted for about 20% of revenue; the outlet stores for about 30%; and the specialty stores for the remaining 50%. 

At Banana Republic, which represents about 10% of total sales, 3Q revenue fell 34% on a 30% decline in comp sales. Banana Republic has suffered from the shift to casual wear. It is responding to changes in customer preferences with new products, the introduction of a ‘buy online, pick-up in store’ program, and a new rental subscription service called Style Passport. It is also using data analytics to strengthen its promotional strategy. Banana Republic closed 60 stores this year, and opened 8 stores, primarily in Asia.

Athleta sales grew 35% in 3Q, with a 37% increase in comparable sales. Management continues to expand the Athleta brand, which outperformed with 12% sales growth and low double-digit earnings growth in FY20. It opened 10 new stores this year and closed two, for a current total of 198 stores. In mid-2019, the company announced its first athlete sponsorship with track and field Olympic champion Allyson Felix. Athleta continues to benefit from recent trends in athletic and lifestyle clothing. 

We are widening our FY21 loss forecast to $2.12 per share from $1.98 and raising our FY22 EPS forecast to $1.26 from $1.14. Our estimates reflect our expectation for sequential sales improvement and continued benefits from cost cutting.

Financial Strength & Dividend

In May 2020, the company issued two new $2.25 billion senior secured notes, and secured a new $1.9 billion credit revolver that replaced its previous unsecured revolver. A portion of the proceeds from the debt issuance was used to redeem its existing $1.25 billion notes due 2021, and to pay down the $500 million drawn on its previous revolving credit facility. There were no borrowings under the ABL credit revolver as of November 1. 

Excluding the stored inventory, inventory declined 7%.

The company has suspended share buybacks and dividend payments due to economic uncertainty.

Management & Risks

Sonia Syngal became the company’s new president and CEO on March 23, 2020, succeeding Arthur Peck, who stepped down in November 2019. Ms. Syngal had been the CEO of Old Navy since 2016. Other senior leadership changes include Katrina O’Connell, previously CFO at Old Navy, who was named CFO of Gap Inc. Mark Breitbard, CEO of Banana Republic, is now also overseeing the company’s specialty brands, which include Gap, Athleta, Janie and Jack, Intermix, and Hill City.

In our view, the company’s near-term growth prospects depend primarily on Old Navy -and the fast-growing but smaller Athleta brand. Both Gap and Banana Republic have been hurt by mall closures in the U.S., as well as by reduced foot traffic at most locations. Old Navy stores are frequently in strip malls or in other stand-alone locations.  

We believe that the company’s greatest challenge will be increasing store traffic and changing consumers’ perceptions about the quality and affordability of products at Gap, Banana Republic and Old Navy. We also note that Gap faces strong competition from other specialty retailers, such as Abercrombie & Fitch and J. rew, as well as from department stores, discount stores and catalogs. In our view, Target, J.C. Penney, H&M and Kohl’s are all making a strong bid for Gap and Old Navy customers.

Company Description

Gap Inc. is a leading specialty retailer of clothing for adults, teens and children. The San Francisco-based company has three main brands: Gap, Banana Republic, and Old Navy. The company had 3,919 stores (3,345 company-operated) in 42 countries at the end of 3Q20, with more than 80% in the U.S. 

Valuation

The shares have recovered from their April lows. We are encouraged by the company’s aggressive moves to transform its business and improve performance, and would consider an upgrade on signs of sustained earnings improvement. However, given recent weak comps, product assortment issues, and slower traffic trends, along with continued economic uncertainty, our rating remains HOLD.

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James Williams
James is our Lead Content Publisher here at Feeds Portal. He has worked with many top websites over the years, including BuzzFeed.

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