What’s Next For Gap Stock?

Note: Gap’s FY’23 ended on February 3, 2024.

After a 24% rise year-to-date (YTD), at the current price of around $22 per share, we believe Gap Inc. stock (NYSE: GPS), a specialty retailer selling casual apparel, accessories, and personal care products for men, women, and children under the Gap, Old Navy, and Banana Republic brands – is appropriately priced. In contrast, its peer Guess (NYSE:GES) stock is down 18% over the same period. Gap experienced a decline in sales momentum over the past two years, with revenues plummeting from $16.7 billion in 2021 to $14.9 billion in 2023, representing an 11% decrease. However, the apparel retailer is leveraging cost-cutting initiatives from the 2022-2023 period to propel sales and earnings expansion, bolstered by key executive appointments, including CEO Richard Dickson.

Turnaround signs have begun to appear, evidenced by a return of positive comps so far in FY 2024. Following the successful closure of 344 underperforming Gap and Banana Republic stores, we anticipate sales growth will increasingly reflect the company’s strategic transformations in the longer term. The company’s revenue grew 3% year-over-year (y-o-y) to $11 billion in the first nine months of FY 2024. The company’s gross profits have increased, which notes an uptick in profitability to $1.70 per share compared to 86 cents per share in the first three quarters of 2023.

The increase in GPS stock over the last 3-year period has been far from consistent, with annual returns being considerably more volatile than the S&P 500. Returns for the stock were -11% in 2021, -33% in 2022, and 97% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is considerably less volatile. And it has outperformed the S&P 500 each year over the same period.

Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment around rate cuts and multiple wars, could GPS face a similar situation as it did in 2021 and 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

The apparel industry’s success hinges on consumer spending, which is closely tied to consumer confidence. Although confidence has rebounded from pandemic lows, it still lags pre-Covid levels. The latest U.S. consumer confidence index increased to 108.7 in October, up from 99.2 in September, signaling optimism among consumers. For perspective, the consumer confidence index reached 132.6 in February 2020, just before the Covid-19 onset.

The company’s comparable sales were up 1% during the third quarter. Segment-wise, Old Navy, which makes up more than half of the company’s revenue, comparable sales were unchanged from last year’s comparison of positive 1%. Gap brand saw a positive 3% comp, and Athleta saw its comp sales grow 5% in Q3 (compared to -19% in Q3 2023).  Banana Republic comp sales fell 1% but that was still better than last year’s 8% decline. Notably, Banana Republic and Athleta brands collectively contribute less than 20% to Gap’s total revenue, highlighting the company’s reliance on its core brands.

As of November 2, Gap’s cash and cash equivalents increased by 46% year-over-year (y-o-y) to $2 billion, while the company’s free cash flow stood at $540 million, comparable to last year. The retailer reported a significant expansion of its gross margin, increasing by 350 basis points to 42.2% in the first nine months of FY 2024. This improvement is primarily attributed to the company’s strategic shift toward reduced promotional activity. In part, that is due to management’s resolution of its inventory problem (inventories down 2% y-o-y in Q3 2024). Overall, the company is seeing strong continued progress on margins and cash flow and also improved trends at its Old Navy and Gap brands.

While investors have their fingers crossed for a soft landing for the U.S. economy, how bad can things get if there is another recession? Our dashboard How Low Can Stocks Go During A Market Crash captures how key stocks fared during and after the last six market crashes.

[1] Returns as of 11/22/2024
[2] Cumulative total returns since the end of 2016