On a day when the markets are down between 1-2%, the fact that Gap (GPS) stock is up almost 2% on the upgrade from Barclays analyst Adrienne Yih, it’s understandable if its long-suffering shareholders are excited about the company’s rising share price.
The analyst upgraded GPS stock from underweight to equal weight on Aug. 30 with a 50% increase in its target price to $9.
“We believe that the sales-to-inventory growth spread at the end of 2Q22 (inventory growth 44% faster than sales, which was only slightly worse than 1Q22's 41%) will be at its maximum negative spread as GPS consciously works down inventory,” Investing.com reported the analyst wrote in a note to clients. “The company is taking measures to aggressively reduce the inventory by liquidating it through markdowns, packing it away for use next year, and dramatically reducing future receipts.”
Yih believes the company is doing all it can to right the ship. This might be true, but when you’ve got so many other retailers to choose from, it seems exceptionally risky to consider buying Gap stock in this kind of trading environment.
I would not be buying at this time. Here’s why I feel this way.
Gap Delivers Surprise Profit
Gap reported its Q2 2022 results on Aug. 25. The shares gained ground due to the company’s surprise profit of $0.18 a share, excluding a 10-cent impact from elevated freight costs, 23 cents better than analyst expectations. Further, it also topped the $3.82 billion sales estimate for the second quarter by $40 million.
So, what’s working at Gap?
Banana Republic was the only banner to deliver any growth in the second quarter, with net sales rising 9% to $539 million, with a same-store sales increase of 8%. Athleta’s sales in the quarter increased by 1% to $344 million, but that was due to the addition of nine new stores in the first half of the fiscal year.
What’s not working?
The company’s biggest banner, Old Navy, accounted for 54% of the overall revenue in the quarter. Unfortunately, its revenue fell 13% to $2.1 billion because of a 15% decrease in same-store sales. As for the legacy Gap banner, its sales were $881 million in the quarter, 10% lower than Q2 2021. Its U.S. same-store sales fell 10%, down 7% globally.
Gone are the days when it could do no wrong.
It’s Fumbled Athleta
Athleta was supposed to be the future of the company. It grew sales in the quarter by just $3 million, spread over one million square feet of retail space. That’s not even an increase of $5 per square foot.
If you annualize Athleta’s $704 million in sales in the first half, the banner generates sales per square foot of $1.41. On a per-store basis, it’s $6.0 million. Lululemon (LULU) had 579 company-operated stores as of May 1. They generated $731.6 million in Q1 2022. On an annualized basis, its stores generated $5.1 million per store.
However, that doesn’t consider Lululemon’s direct-to-consumer (DTC) sales while including Athleta’s online numbers in that $6-million figure.
Lululemon’s DTC revenues were $721.3 million in the first quarter. They accounted for 45% of its sales and 61% of its operating income. Gap’s online sales accounted for 36% of its $7.33 billion first-half revenue. However, they decreased by 12%. Lululemon’s DTC sales increased by 32%.
Gap acquired Athleta for $148 million in September 2008. That was approximately 3.5x sales of $43 million. So, while it’s done a reasonably good job of growing sales over the past 13 years, that had a lot to do with changing customer tastes. LULU wasn’t the only brand to benefit from the push to more casual clothing.
I don’t believe there’s any comparison between the two.
Gap’s Valuation Isn't Going Anywhere
The company withdrew its guidance for the second half of 2022, stating that while it was cautiously optimistic about its sales over the final two quarters, it has a lot of work to return the company to profitable growth.
It plans to open between 30 and 40 Athleta stores in fiscal 2022. It opened 13 in the first half. That means it will open between 17 and 27 stores over the final six months of 2022. It also plans to open as many as 30 Old Navy stores while closing several Gap and Banana Republic locations.
Based on the analyst’s $9 target price and 363.7 million shares outstanding, she’s putting a valuation of $3.27 billion. That’s less than its current market cap of $3.55 billion.
While it’s possible that the analyst will increase the target price again once it’s reported Q3 results in November, it’s also possible that all four of its brands will struggle from here through the end of its fiscal year in January.
This is not a name I would want to own heading into the six-week holiday shopping season.
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