The venerable old Gap Inc (GPS) is an iconic American retailer that has been around for nearly 50 years. Unfortunately, it may be floundering again. On Monday, GPS warned that first quarter results would be disappointing, and Gap stock lost 10% of its value after hours on the news.
Fashion retail is a notoriously competitive business with a high attrition rate. Tastes change, brands get tired and it becomes an exercise in staying one step ahead of fickle consumers. That would be hard for even a fresh, new brand to navigate. Add decades of inertia to the mix, and it gets even harder.
Last year, Gap announced it would be closing about a quarter of its Gap-branded stores, and now it looks like cuts will be coming to Old Navy and Banana Republic as well.
What’s in Store for GPS Stock?
It really shouldn’t come as a surprise. GPS’s annual revenues haven’t budged in over a decade. Trailing 12-month revenues are sitting at levels first seen in 2003.
And remember, these numbers are not adjusted for inflation. In real terms, GPS’s revenues have actually fallen by nearly a quarter.
That’s just flat-out ugly, though the story isn’t all bad. While GPS has struggled to grow, it has managed to maintain respectable profitability. Over the same time period, gross margins have bounced around in a range of about 34% to 40%. And while net margins have been fairly skimpy, they’ve also been pretty consistent.
Gap hasn’t had a single unprofitable year since 2002, and net margins have ranged from 3.3% to 8.2%. Last year, they finished in the middle of the range at 5.8%.
While operational results have been a disappointment, I can credibly say that GPS has been generous with its shareholders. Management has repurchased nearly 60% of Gap shares outstanding since 2005, and the company has boosted its dividend at an 18% annualized rate for the past 10 years.
Yet for all this shareholder friendliness, GPS shareholders don’t have a lot to show for it. Between 2012 and 2014, GPS stock more than doubled in value … only to give it all back in 2015 and 2016. As I’m writing this article, GPS stock trades hands at a little over $19 per share … where it traded in late 2003, during the first presidential term of George W. Bush.
So, what’s the call here? Gap is clearly a struggling retailer. But considering that the stock price hasn’t budged in over a decade, might it be a decent contrarian value play? Let’s take a look.
Gap stock yields an attractive 4.2% in dividends, and the payout ratio sits at a modest 41%. So even if growth is a little hard to come by, GPS’s dividend should be safe for the foreseeable future.
At current valuations, investors certainly aren’t paying for growth. GPS stock trades for just 8 times earnings and 0.55 times sales. The apparel industry as a whole trades for 17 times earnings and 0.74 times sales. So a fair bit of pessimism is already baked into the Gap stock price.
But is it enough?
As a general rule, I try not to catch falling knives, so I’m sitting on the sidelines for now. Gap stock looks reasonably cheap to me, and I consider the 4% dividend to be very attractive. And earlier this year, Gap announced it would be buying back an additional $1 billion of its stock.
At current prices, that’s nearly 15% of Gap’s market cap. So between dividends and buybacks, I believe that patient value investors will eke out a very respectable return in Gap stock. But I’d recommend waiting another few weeks before buying shares.
Earnings will be released on May 19, and I’d recommend waiting until after the release to buy. With the bad news already out this week, I’m not expecting any surprises in the official earnings release. But I’m also not expecting the stock to mount much of a rally between now and then.
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he did not hold a position in any of the aforementioned securities.
