Gap (GPS)

mall

Key Statistics

Enterprise Value = $9.397 billion

Operating Income = $1.386 billion

EV/Operating Income = 6.77x

Earnings Yield = 10%

Price/Revenue = .56x

Debt/Equity = 36%

The Company

Gap is a retailer. Have you been to the mall in the last 20 years? Have you seen its commercials trying to convince you to buy khakis? I’m fairly certain you’re familiar with them. (Personally, I buy most of clothes at K-Mart, Wal Mart, and Costco, but whatever.)

The company is not simply the Gap stores in malls. They also own Banana Republic and Old Navy. Banana Republic is pricier than both Old Navy and Gap. Old Navy is the discount apparel retailer that is currently driving the company’s growth. Old Navy has continued growing while the other two segments have been in decline. Old Navy grew sales by 6% in 2017 while both Gap and Bananan Republic experienced sales decline as customers shy away from the mall.

Gap was beat up by the retail carnage a few years ago. From 2014 through its 2016 low, Gap went from around $40/share to a low of $17 in mid-2016. From there, as Mr. Market woke up and realized that most apparel transactions still happen in a store, the stock recovered to $35 in January 2018.

From the heights of $35/share, the stock has been punished again over the last year after some choppy quarters, but the news has hardly been devastating. The stock has also been punished by concerns over a trade war that isn’t yet showing up in the actual results.

My Take

Yes, I’m diving back into this category again – retailers punished by the sentiment that Amazon is eating brick and mortar retail. I keep ignoring the warnings. Like Z’Ha’Dum, the advice is: if you go there, you will die. I keep going there anyway.

Anyway, I think I made a few good picks in the retail sector (American Eagle, Dillard’s, Foot Locker, Dick’s), but this area has largely been a wasteland for my portfolio. Fortunately, I exited the dumpster fires like Francesca’s and Big Five after they posted operating losses. I even got out of Big Five for a slight profit! This is shocking considering the stock is down 68% year to date. In retrospect, the best way to play a beaten up sector is to own more of them in smaller chunks. I made “big” bets on a small handful of dirt cheap ones, but I probably should have been more diversified among a broad number of stocks in the group.

The trade is now played out. Retail recovered as a sector, even though I didn’t always have the right picks. Even after that after the run up, Gap looks to me like one of the best of the bunch and the multiple has been compressed due to some slight underperformance in business results along with trade war jitters.

Gap hasn’t posted a loss at any point in the last decade. Even in the depths of the Great Recession, it still earned $1.34/share. It has also maintained profitability throughout the last few years of intense competition with online brands. They also began a restructuring effort in 2016, which is working. They closed 75 stores internationally that were not performing and realized a $275 million cost savings. I find this encouraging, especially compared to my experience in Francesca’s, which continued to open new stores even while the existing stores were posting terrible results. Gap has a strong shareholder orientation in this regard.

Gap is very well run with a high degree of financial quality. The F-Score is a perfect 9 out of 9. The Altman Z-Score is currently 4.73, implying an extremely low risk of bankruptcy. The debt to equity ratio of 36% compares favorably to industry averages, which currently averages 68%. The company also has a high degree of yield. Last year, they bought back 2% of the existing share count and the current dividend yield is 3.94%.

Gap’s current valuations compare favorably to the industry and its history. Gap’s current P/E of 10.29 compares to an industry average of 14.32. A P/E of 14-15 seems reasonable to me for a steadily performing and financially healthy retailer. On a price/sales basis, Gap’s current ratio of 56% compares to a 5-year average of 83%. On an EV/EBIT basis, Gap’s current level of 6.77x compares to its 5-year average of 7.68. The forward P/E is 9, implying analysts don’t expect any kind of operational loss in the upcoming year.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.