Here’s Why We Think Gap Inc Is Worth $50 – Part 1

Gap Inc (NYSE:GPS) is a global specialty retailer which offers clothing, accessories and personal care products for men, women and children under the labels Gap, Old Navy, Banana Republic, Piperlime and Athleta. Over the past year, the company has performed relatively better than its peers, such as Aeropostale (NYSE:ARO), American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch (NYSE:AEO), with a sharp response to changing fashion trends. Despite the prevailing weakness in the U.S. apparel market, Gap Inc’s comparable store sales increased by 1%, 5% and 2% respectively, during the last three quarters.

With steady growth in the U.S. and abroad, Gap Inc’s stock price has risen by more than 20% over the last 12 months. We believe that there is still some value to be unlocked in the company. Our price estimate of $50 is about 30% premium to the market price. In the current scenario where U.S. buyers have shown low brand loyalty, Gap Inc has maintained a strong connection with its customers with appealing marketing campaigns anddesirable products. This should help the company drive store and web traffic in the future as well. Additionally, Gap Inc is focusing on smaller brands to gain further market share in the U.S. Brands such as Athleta, Piperlime, Intermix, GapKids and babyGap have done reasonably well so far, and the U.S. market provides sufficient room for future expansion.

Also, targeted international expansion and a strong direct-to-consumer channel are likely to play crucial roles in its long term growth. We will discuss these two factors in a separate note that will follow soon.

See our complete analysis for Gap Inc.

Gap Inc Knows What Its Customers Want

This year, U.S. buyers have shown low brand loyalty, as they have been readily moving to brands that offer the most desirable and latest fashion at affordable prices. As a result, there has been a gradual shift of customers from retailers such as American Eagle Outfitters, Aeroposatle, and Abercrombie & Fitch to fast-fashion brands such as Gap Inc, Zara, Forever 21 and H&M. The reason why Gap Inc has enjoyed this trend is because it caters to a large demographic, knows what its customers want and connects with them in appealing ways. The retailer offers its three main brands — Old Navy, Gap and Banana Republic — at different price points and creates separate shopping experiences around each of these brands.

Old Navy mainly offers casual clothing at affordable prices for value and trend conscious high school and college students. The website reflects an array of vibrant colors and features different products under discounts every week. It shuffles between categories such as women’s dresses, jeans for the entire family, swim suits, flip flops, etc. That way it covers a wider customer base while maintaining interest in the brand. At Gap, the company offers its products at higher prices than Old Navy and targets working professionals along with teenagers. The brand’s website is more subtle, with products such as polos, jeans, khakis and cardigans. Banana Republic is Gap Inc’s affordable luxury brand, which has an organized website reflecting a sense of expensiveness. It offers versatile workwear for men and women for all occasions, ranging from desk to dinner. Occasionally, the brand partners with leading designers to offer an exclusive and limited addition collection. Banana Republic serves as a viable shopping option for affluent buyers who are looking to add some class to their workplace attire. Although Gap Inc is a casual apparel retailer, it has created different markets for itself with each brand targeting distinct groups of buyers. This has worked well for the company so far and is likely to continue the same way.

Additionally, Gap Inc. is leveraging fashion blogs to promote its brand image among U.S. buyers. About a couple of years back, the retailer introduced a website Styld.by in partnership with popular fashion and lifestyle blogs such as Lookbook, FabSugar, etc. From time to time, Gap Inc. features its collections on these blogs since they serve as a valuable medium for company-customer interaction. According to a 2011 Technorati report, while consumer trust on traditional media had declined by 46% since 2006, around 35% consumers trusted blogs to be credible sources of information. Interestingly, 19% agreed with the idea that they are better written than traditional media sources. ^[1] Gap’s Styld.by blog partners collectively have about 1 million average unique monthly visitors. This strategy is helping the retailer generate more interest among customers.

It Can Gain Market Share In The U.S.

While Gap Inc is consolidating its main brand networks in North America, it is looking at other ways to gain share in $300+ billion U.S. apparel market. Apart from expanding Banana Republic, the retailer is relying on smaller brands for the purpose. In an investor meeting held in April 2013, the company stated that it will focus on Athleta, Piperlime, Intermix, GapKids and babyGap to grow its business in North America. ^[2]

Through Athleta, Gap Inc offers performance driven sports apparel and footwear for women. The retailer is planning to expand the brand’s footprint in the U.S., which is currently limited to just 61 stores ( Q3 2013). It opened about 31 Athleta stores over the last one year and its likely to touch 100 this year. We believe that this is a good time for Athleta’s expansion, as its main competitor Lululemon is struggling with bad publicity. According to SW Retail Advisors, Athleta is the number one contender to benefit from Lululemon’s problems, as it has hired some valuable talent and is looking to replicate Lululemon’s success story. ^[3]

Additionally, Gap Inc is planning to open physical stores for its formerly exclusive online brand Piperlime (shoes, accessories and handbags). Although the company operates only one Piperlime store at the moment, it is likely to expand in the future. Gap Inc also added Intermix (women’s fashion botique acquired a year back) to its online channel. Moreover, GapKids and babyGap are very popular brands in their respective segments, and can provide some support to the company’s long term growth.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. State of the Blogoshpere 2011, Technorati, Nov 4 2011 [↩]
2. The Gap’s CEO Hosts 2013 Investor Meeting, April 17 2013 [↩]
3. The race to muscle Lululemon out of its turf, CNBC, Nov 14 2013 [↩]