GPS Stock: Gap Inc Is Shrinking, But for the Better

If there was any doubt that trendy retailer Gap Inc (GPS) was in trouble, its first-quarter numbers posted after Thursday’s close confirmed it. The company has now logged five straight quarters of declining sales, and it didn’t exactly serve up an encouraging outlook for the remainder of the year. Plans to pull the plug on a few dozen stores only underscores the hopelessness of the headwind.

Gap Inc GPS stock

And yet, GPS stock was flipping between flat performance and even some gains after Thursday’s after-hours trading session.

Does the market finally have faith in where the company is going rather than doubts stemming from where it’s been?

In a word, yes … and given the stock’s valuation, it may not be a bad bet.

Gap Inc Earnings

All told, Gap Inc earned 32 cents per share last quarter on $3.44 billion worth of revenue. Both figures were in line with estimates. They were both shy of year-ago numbers though, when the company earned 56 cents per share on $3.66 billion worth of sales. Same-store sales fell 5%.

And no part of the quarterly report was especially encouraging.

Global Gap sales fell 3%, Banana Republic’s revenue was 11% lower on a year-over-year basis, and Old Navy saw its top line slump 6% versus Q1-2015’s figure. All regions and brand stratifications reported falling sales, save the “other” category, which saw revenue grow from $175 million a year earlier to $178 million last quarter.

CEO Art Peck commented on the Q1 results:

“As the pace of change across the apparel industry increases, now is the time to accelerate our transformation by scaling our product and operating capabilities across our global portfolio. By taking every opportunity to exploit our strategic advantages, our brands will be able to more fully harness the power of the enterprise to better serve their customers across channels and geographies.”

Peck’s first step: Shrinking the company’s way to success, for one.

Gap plans to close a total of 75 venues, 53 of which are Old Navy stores located in Japan. While it’s a step back, it’s a step in the right direction for the long haul, and part of Peck’s two-pronged plan: focusing on geographies with the most potential, and streamlining its operating model.

Between the two, Gap anticipates an annual pre-tax savings of $275 million despite the $250 million in revenue it would be giving up to shutter those 75 units. The move would widen operating margins by a couple of percentage points.

Reality Check

The optimism and strategizing has been heard before, mostly to no avail. What changed this time around that investors weren’t killing GPS stock?

Perhaps more than anything, the decision to close another 75 stores is a tough-but-smart decision.

In June of last year, GPS announced it would shutter 175 units by early this year. To what extent those planned closures overlap with Thursday’s announcement isn’t clear, but it’s refreshing that Peck is willing to make tough, realistic choices. Indeed, Gap investors may have been counting on something far more alarming.

GPS stock lost 63% of its value between September 2014 and Thursday’s close, largely reflective of an extreme deterioration of the company’s revenue and earnings. The sellers may have overshot though. GPS shares are presently valued at a trailing price-to-earnings ratio of 7.7 and a forward-looking P/E of 8.4.

Although Gap was suspiciously cryptic about its earnings guidance for fiscal 2016 — by virtue of not reaffirming its previous profit guidance but not giving any updated numbers — even a worst-plausible-case scenario would still leave GPS at bargain-level valuations.

Bottom Line for GPS Stock

It’s uncomfortable to catch a falling knife, which is exactly what Gap Inc has been more months now. But, between a single-digit valuation and a business plan that finally acknowledges one of the bigger challenges for the company (dead-weight stores), GPS may be a knife worth catching, even if for a short while.

The purpose of buying it here and now will be to establish a profit cushion before the next quarterly report, which will either begin to validate or invalidate the company’s newest initiatives.

It’s still not an investment you can turn your back on, though.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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