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In a recent conference call, Gap Inc. (NYSE:GPS) announced better-than-expected first-quarter results, citing improved comparable-store sales and earnings that increased from $0.47 per share to $0.71 per share year over year. During the call, Gap inc. reaffirmed guidance for the year 2013. However, in the days following the earnings announcement shares of GPS did not respond as favorably as some would have expected. Shares have fallen as much as 4% in the days following the earnings announcement. At the time of writing shares of GPS were trading around $39.99, up around 27.48% on the year. Shares are trading just below the 52-week high of $41.86. Likewise, The Street has reaffirmed a buy rating for GPS.

2012 Financial Details:

  • Gap Inc. represents a very strong cash position in comparison to peers. As noted in the chart below, Gap Inc. has substantially more cash than all of the major industry players.

    Symbol

    Cash (Feb. 2013)*

    URBN

    $245,327.00

    GPS

    $1,460,000.00

    ANF

    $643,505.00

    AEO

    $509,119.00

    ARO

    $231,501.00

    Gap holds a cash position that is more than double that of ANF and nearly triple that of AEO.

  • An analysis of Gap Inc.'s free cash flow provides great insight into Gap Inc.'s ability to generate cash and thus generate profits. Likewise free cash flow can represent cash that may be available to be returned to shareholders. Free cash flow data (computed as cash flows from operations less capital expenditures) for the year ended 2012 is represented in the table below:

    Symbol

    Cash Flows From Operations*

    Capital Expenditures*

    Free Cash Flow*

    URBN

    $395,680.00

    -$168,875.00

    $226,805.00

    GPS

    $711,000.00

    -$210,000.00

    $501,000.00

    ANF

    $464,847.00

    -$61,911.00

    $402,936.00

    AEO

    $499,671.00

    -$93,939.00

    $405,732.00

    ARO

    $144,811.00

    -$72,309.00

    $72,502.00

    In the year 2012, Gap Inc. was able to generate a significantly larger free cash flow than smaller peers Urban Outfitters (NASDAQ:URBN) and Aeropostale (NYSE:ARO). The outliers here are ANF and AEO. A look at the profit generated per store can add clarity to the similar free cash flow numbers. Profit per store information is represented in the table below:

    Symbol

    Stores

    Profits*

    Profit Per Store*

    URBN

    401

    $1,031,531.00

    $2,572.39

    GPS

    3263

    $6,171,000.00

    $189.12

    ANF

    1065

    $2,816,709.00

    $2,644.79

    AEO

    1069

    $1,390,322.00

    $1,300.58

    ARO

    1091

    $589,357.00

    $540.19

    While Gap Inc. physically operates more stores than its competition, profits on a per store basis were a mere fraction of those put forth by the competition. In comparing the free cash flow numbers to the profit per store numbers, Abercrombie and Fitch (NYSE:ANF) was able to generate free cash flow numbers comparable to gap within a smaller physical presence. A quick glance at the Abercrombie website shows men's polo shirts for sale for as low as $39.00. A comparable item for sale on the Gap website sells for $29.99 (AEO offers a men's polo for as little as $24.99). This is significant as the difference in pricing per this one item is 33% but the difference in profit per store between GPS and ANF was over 1398%. This suggests that margins alone are not the only factor influencing greater profit per store numbers.

  • Gap Inc. pays a dividend in line with that of Abercrombie and Fitch and American Eagle Outfitters (NYSE:AEO). Aeropostale and Urban Outfitters do not pay a dividend. Dividend data represented in the table below:

Symbol

Dividend

Annualized Percentage

ANF

$0.80

1.60%

GPS

$0.60

1.50%

AEO

$0.44

2.20%

*Numbers in thousands, Source Yahoo Finance

Brand Diversity and Expansion Plans

Gap currently owns six major brands, allowing for exposure to varying market segments. This is significant as Urban Outfitters owns five brands, Abercrombie and Fitch owns four brands, American Eagle Operates three brands, and Aeropostale owns two brands. Gap brands including Gap, Banana Republic, Old Navy, Piperlime, Athletica, and Intermix represent a diverse blend of apparel needs including athletic wear, footwear, business wear, casual wear and low-cost options. In comparison, URBN brands Anthropologie and Free People are notorious for being premium brands that command premium pricing.

Gap inc. has an international expansion model that is based on franchising. Gap currently has franchising agreements within Europe, Asia and the Middle East. Gap has also recently announced expansion of its Old Navy Brand within Japan.

Investor Rationale

Investors should find security within the GPS dividend. A strong free cash flow and substantial cash position will allow the company to return cash to shareholders without worry. GPS has demonstrated an expansionary history with the acquisition of Intermix. Having cash on hand increases the likelihood that more acquisitions could occur. Likewise, investors should find security within the diverse portfolio of GPS brands. The Gap offerings appeal to a wide array of customers on all price points whereas some competing firms only cater to high-end or low-end clientele. Finally, investors should find security in the bold GPS international expansion plan. GPS currently faces some competition within Europe from British Based H+M as well as URBN. However, the company has a strong foothold within Asia and the Middle East. However, a franchise based international model allows the company to succeed abroad as franchises will purchase inventory directly from Gap or a Gap-specified supplier.

Investors should complete more due diligence with regards to GPS share performance. While Gap may have the most cash and generate the most free cash flow, it requires a significantly greater number of stores to generate numbers similar to smaller-sized peers. After analyzing the results of 2012, it appears as though GPS competitors are generating more profits from a smaller presence, a fact pattern that could hurt GPS moving forward.

Disclaimer: One should complete one's own additional research before making investment choices.

Source: After Earnings Can Gap Inc. Still Match Up To The Competition?