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Gap: One of the Most Attractive Stocks in Apparel

Store closings and head-count reductions should drive margin expansion in coming years, says Morningstar.

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On Monday,  Gap (GPS) announced plans to close 175 Gap stores in North America within the next few years, and eliminate 250 jobs at its corporate office. The stock price is down nearly 8% for the year.

Bridget Weishaar, who covers the stock for Morningstar, sees opportunity in Gap’s stock today. In her latest  Stock Analyst Note, Weishaar explains why she finds Gap compelling:

“We left Gap's investor day incrementally more positive on our belief in an early 2016 top-line recovery and the company's long-term margin opportunity. With a focus on brand definition and perfecting product, management appears to be addressing its core issues and using data, testing, technology, and supply chain advances to support improvement. We think these efforts will improve comparable sales consistency and lead to average annual low-single-digit comparable sales growth beginning in 2016.

Furthermore, we see near-term catalysts including store closures as well as headcount reductions, in addition to the longer-term responsive supply chain development, leading to margin expansion from current low double digits to the mid-teens over the next five years. With the stock trading about 20% below our $49 fair value estimate, we continue to think Gap is one of the most attractive names in the apparel sector.”

In her latest  Analyst Report, Weishaar described Gap as an iconic brand and assigns it a narrow moat rating, reflecting the strength of the Gap and Old Navy brand intangible assets and for the cost efficiencies stemming from the company’s economies of scale. She continues:

“On many fronts Gap is succeeding. The company has been right-sizing its store base while growing its online presence, shedding about 14% of the North America specialty fleet since 2008 and growing e-commerce to 14% of sales in 2013 (roughly doubling in five years). In fact, rebalancing the portfolio toward online, outlet stores (550 by the end of 2014), and franchise stores (450 stores by end of 2014) has contributed about 12 points of contribution shifts toward higher returning channels since 2008 (now 31% of business).

We think further margin expansion is on the horizon and that this is an underappreciated opportunity.”

Morningstar Premium Members gain exclusive access to our full Gap Report, including fair value estimates, consider buying/selling prices, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.  

Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.