Mind The Gap: The Clothing Retailer May Be Expecting Long-Term Success

| About: The Gap, (GPS)

There are very few apparel retailers that the average American would recognize more than The Gap (NYSE:GPS), now known as simply "Gap". The company has been in existence since the late 60s and has been encompassing American suburbia since. As of late, however, it appears that at least on a financial level the company has been struggling. They announced in late 2011 that they plan to close approximately 200 stores in the US while expanding overseas-- perhaps a silver lining. On the other hand, all of this could be interpreted as a strategic maneuver on part of the company as it may be time to push into foreign markets and change many managerial heads. Both of these components need to be thoroughly discussed before determining Gap's ultimate fate.


A few weeks ago Gap announced the hiring of acclaimed designer Rebekka Bay as creative director and head of global design for the company. At this point in Gap's timeline, Bay may be exactly what the apparel enterprise needs to continue its success.

Bay previously founded the H&M-owned COS brand, which produces a slightly higher-quality product than its parent company for sale in Europe. Adding to an already trendy brand, COS emphasizes a more modern look-even by European standards. For the majority of its existence, Gap has focused on the average consumer. The majority of their products attempt to be relatable to the bulk of American society-fashion essentials, standard fitting and versatile in appearance. This juxtaposition is precisely why Bay's hiring peaked our interests. Given this contrast in styles, it's possible that Bay intends to steer Gap into this new market, thus shifting away from the traditional norm it has held for so long.

Aside from Rebekka Bay designing Gap's products, the retailer announced last week that it is hiring former JC Penny (NYSE:JCP) and Target (NYSE:TGT) creative director Michael Francis to its team. Although Francis had a stint at Penny, he is most renowned for his work with Target, where he revolutionized the company and made it the powerhouse it is today. His work with the Minneapolis-based retailer involved taking a seemingly higher-quality store and catering it for cost-conscious individuals, with the clothing brand Merona serving as a key example. This combination of chic and cost is exactly what Gap needs. Combining the talents of Francis and Bay is putting Gap on a course to produce a high-quality and trendy clothing line, while retaining many of the lower prices its customers enjoy today.

This combination of qualities serves a few purposes:

  1. Product portfolio diversification. At the moment, we see that Gap and its subsidiary, Old Navy are slowly approaching the same horizon as they both produce the same style of clothing; the primary difference being Old Navy's lower prices. Over the long term, a static business model for both companies could see Old Navy cannibalizing Gap's profits, as consumers will opt to shop at the lower-cost retailer instead.
  2. Opening Gap to other competitors. Trendy brands such as H&M, Forever 21, and ASOS (LSE:ASC) operate in a league of their own. All three share a similar strategy of bringing fashionable, European styles to American shoppers at a heavy discount to designer prices. All three of these companies are relatively small compared Gap. As such, the company sees this as prime territory to enter. Given the name recognition Gap already has, providing an alternative source for these clothing styles can easily increase overall profits.
  3. Supporting Banana Republic. Gap's third primary brand is the upscale retailer Banana Republic, servicing the more conservative and modern stylings that Gap and Old Navy fail to do. Banana Republic's largest competitor in the US is currently J. Crew, who's current head, Mickey Drexler served as CEO of Gap in the 90s. J. Crew attempts to access the market of both fashion-conscious individuals and sleek professionals, so much as securing First Lady Michelle Obama as a fan. Bringing Gap into this new light can couple with Banana Republic's already market prowess and address J. Crew head-on.

To rewind back to April, Gap announced what would be the first instrument of their managerial trio. The retailer included the former H&M sales director, Stef Larsson to its creative team, specifically the global brand president of Old Navy.

Larsson spent over fifteen years at the European fashion house and was responsible for its rise from a relatively small company with little brand recognition, to one of the most noticeable names in Europe with a strong American presence. Revenues increased from $3 billion to approximately $17 billion during his tenure.

From these three individuals joining Gap, it's evident that some major changes are in store for the brand.

International Exposure

With the late-2011 announcement, investors became skeptical at the long-term success of the company given these US closings. However, they also announced that along with these closings come over 30 new stores to be opened in China through 2013. We feel that Chinese exposure for the brand is perfect for a few reasons.

  1. Chinese citizens are infatuated by Western clothing. For the past decade, the middle to upper class has blossomed and the Chinese have been spending more and more on conspicuous items. Chinese retail sales grew at a rate of over 17% year-over-year in 2011, with that number dipping to around 14% so far in 2012. Furthermore, the implication here for Gap (as well as other international retailers) is that this demand is coming not from clothing made in China for domestic sales, but from imported, overseas brands. With the rise of capitalist policies and the steady opening of China's markets to foreign investment comes an emphasis on status. Malls in large Chinese cities have been opening filled with everything from Uniqlo to H&M to replicas of Rodeo Drive. Even with steep price increases, the Chinese are buying. The interesting side effect is that the upper-middle class are shunning "traditional" brands such as Louis Vuitton and Gucci as they have become too mainstream in China, so much in fact that fake bags are ubiquitous in cities. This is where Gap comes in. Granted, the cheaper retailer cannot be compared to Italian designers, but it offers the less wealthy middle-class access to an American phenom. Gap does not have much exposure in China yet; continued store growth is a good way to allow more and more Chinese citizens to show off their ability to afford western fashion.
  2. China serves as a stepping stone for the rest of Asia. Chinese pop culture is intrinsically linked to everything from Korean games and music to Japanese electronics and television shows. This interconnectedness makes China not so unique in terms of culture. What this means is that the success of Gap in China will be a good indicator of its success in similar Asian countries. Trendy brands like Japan's Uniqlo and H&M already have a strong Asian presence, so it would be reasonable for the new Gap to have a similar effect on the populace.


Gap's recent growth has been commendable. In its most recent quarter, Gap's net income rose 28.6% from the same quarter last year and outperformed most of the industry. The biggest appeal of Gap's financials has been a second quarter earnings-per-share growth of 40% which has yielded its stock appreciation of over 117% in the past year. Furthermore, the company has seen an increase in their pre-tax income is up 29% over the past four quarters.

Going through with the new international stores, Gap is expecting to gain approximately 30% of their total revenue from these sources, which should assist the slightly lagging North American sales.

Another of Gap's redeemable qualities is their focus on maintaining a relatively high operating margin as it has increased consistently over the past three quarters. Comparing to three peers, it is clearly beating the norm as American Eagle Outfitters (AEO, which is currently professing many analyst accolades, is indeed comparable, yet it seems that the fluctuating numbers prevent an accurate pattern or projection from forming.



Gap may not have had the most stellar 2011, but that doesn't prevent the company from looking towards the future with high hopes. The three new additions to the retailer's management team provide ample evidence that the company should see changes in the near future. Old Navy will likely become what Gap is today, maintaining the traditional American styles at an affordable price, while Gap proper may transition into a trendier boutique of sorts, rivaling European competitor H&M, as this will help propel Gap's popularity in the Asian market even further. Granted, much of this is speculative, yet the strategic positioning of these three new members suggests that such a plan may very well be in the cards.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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