Gap (NYSE:GPS) shares closed at $17.66 on June 24. Since May 19, shares are down more than 23%. At these current prices, Gap deserves a closer examination to see if a nice buying opportunity has emerged.
First some basics. Founded in 1969, Gap is a clothing retailer headquartered in San Francisco with a market cap of $9.72 billion. Gap shares have a 52-week high of $23.73 and a 52-week low of $16.62. The company operates 3,248 corporate and franchise stores worldwide in five business segments: Gap stores, Banana Republic stores, Old Navy stores, Athleta stores and the Piperlime online boutique.
The company expects to open 200 stores and close 125 stores in 2011. As of 2011, Gap and Old Navy stores each made up approximately 40% of sales and Banana Republic stores contributed 17. We can break the stores down further below:
|Brand||Total Stores Q1 2011||Expected Openings 2011||Expected Closings 2011||Expected Net Openings 2011|
|Old Navy N.A.||1,027||30||(45)||(15)|
|Banana Republic N.A.||576||15||(10)||(5)|
|Total Company Stores||3,068||125||(125)||0|
Source: Gap 2010 Annual Report
Gap currently is trading with a P/E of 9.3. That looks fairly cheap compared to competitors like Urban Outfitters (NASDAQ:URBN) with a P/E of 19 and American Eagle Outfitters (NYSE:AEO) with a P/E of 15.7. If we extend Gap's P/E back five years, it averages out to approximately 15. Additionally, in February of 2011 the company reported that the board of directors authorized an additional $2 billion for share repurchases; over the past two years, the company has repurchased approximately 28 million shares.
The company has a dividend yield of 2.5%, which may not seem like a whole lot, but compared to other retailers offering no dividends, Gap's dividend looks quite promising. EBITDA is currently $2.44 billion, up every fiscal year since 2007, and the company has $2.42 billion in cash on its balance sheet. However, GPS does have a debt-to-equity ratio of 1.13. Additionally, operating margins for Gap are currently 13% and net margins are 7%.
The company appears to be at a crossroads. The first quarter of 2011 was tough for the company and shareholders. Gross profit fell 6.9%, same-store sales fell 3% and net sales slid 1% yoy. The sluggish quarter was attributed to rising commodity prices, setbacks in Japan and poor consumer traffic in the stores.
CEO Glenn Murphy recently announced plans to increase operating margins and restructure the company due to changing economic conditions. Gap plans to close 200 Gap brand stores and increase the number of outlet stores, of which 40 will be Banana Republic outlet stores. Banana Republic outlet stores return margins of nearly 17%, compared to an average margin of 13% for all Gap segments.
Gap is also planning on increasing international and online operations; the company plans to recieve 30% of total sales from those two segments by 2013. Currently only 8% of total sales come from online segments.
Gap appears to be a mixed bag going forward. It's focused future sales in online and retail segments, areas Gap looks to benefit from in the future. The company has also come to the understanding that the American market has matured and that the economy remains sluggish; Gap plans to increase outlet stores and close down underperforming stores. Though the last quarter for Gap was tough to say the least, it remains to be seen whether or not its restructuring proves to be successful.
Factors to Consider
Gap, like any clothing retailer, operates in a tough business environment. In Gap's annual report for 2010, the company listed 18 concerns and uncertainties going into the future, which include:
- Rising commodity prices: Rising cotton prices have been trimming into the profit margins of all retailers recently. Gap has been hit hard by rising cotton prices and the company must either pass the prices on to the consumer or take a hit.
- Competition from other retailers: Gap faces stiff competition from other clothing retailers. Domestic companies like AEO and Urban Outfitters remain strong and international companies such as Zara and H&M continue to penetrate the American market.
- Success of international expansion: The company continues to grow the number of international stores and enter into Asia and SE Europe.
- Sluggish economic growth and future consumer spending patterns: Gap attributed the most recent quarterly slump to sluggish growth and decreased consumer spending.
- Keeping up with fashion trends: Fashion trends are constantly changing. Gap must keep up with what's in style to remain successful.
- Debt: The company has $1.25 billion in long-term debt and $4.26 billion in total liabilities. Shareholders must remain on the look out if the company takes on additional amounts of debt.
- Rising costs of labor: Many of the clothes sold in Gap stores are manufactured in countries with cheap labor. If labor costs rise, Gap must either pass costs on to the consumer or look for labor elsewhere.
Gap looks like an interesting play due to its recent sell off. Shares are trading at a P/E of 9.3 and are trading at lower multiples than in the past. The company is restructuring itself to cater to international markets and to consumers in this sluggish economy. It appears that the American market has matured and the company's future growth lies in international markets and through online sales. Gap has a fairly healthy balance sheet, has been buying back large amounts of shares and offers a nice dividend compared to other retailers. I believe Gap will bounce back.
Disclosure: I am long URBN.