It’s been a breath of fresh air seeing traditional retailers rallying in the fourth quarter. One of the better performers has been Gap Inc (NYSE:GPS). While many retailers had been down on the year entering the fourth quarter, GPS stock was actually on its highs. So what to make of this red-hot retailer?
Over the last three months, Gap stock is now up 30%. It’s had a good 2017, as last quarter (fiscal Q3) Gap Inc turned in its fourth straight quarterly comparable-store sales gain. That’s great news for a retailer!
That said, 2018 won’t be an easy year. Gap Inc is doing well with its Athleta line and its Old Navy unit has put up 5% comp-store sales for the year. It will be hard to grow on top of that next year.
Gap Stock in 2018
As an investor, betting on GPS stock to have a repeat year would be unrealistic. After all, the time to buy most of these retail names would have been in the summer. At the time, Gap stock was trading in the very low $20s and investors would already be up 50% had they bought then.
Mid-summer also seemed to be when we were near “peak Amazon.com, Inc. (NASDAQ:AMZN)” in my view. The company had just bought Whole Foods Markets for some $13.7 billion. AMZN’s growth is no joke, but the idea that it will ruin every retailer on earth is foolish.
That’s where Gap stock stands out. Given its low price points of Old Navy, and Athleta compared to Lululemon Athletica Inc. (NASDAQ:LULU), I think both of Gap’s units will be winners this holiday season. The U.S. consumer is doing well and these make for great, low-priced gifts around the holiday.
Anyway, back to 2018. Analysts currently expect earnings to grow about 4% next year, along with 1.2% sales growth. It’s far from robust. But any type of growth in retail is good growth at this point. Let’s also not forget what type of impact the tax bill could have on Gap stock.
For 2017, management expects to pay an effective tax rate of 38%. That figure will surely decline should the tax bill pass, thus passing more money down to Gap’s bottom line. Further, any sort of lift from Banana Republic will be a big boost to Gap, as this unit has been a drag on operations.
Trading Gap Stock
So why is $30 such an important level? In November 2016 and October 2017, the stock rallied hard to this level. But once it got to $30, it couldn’t push through and immediately fell by more than 10% both times. But in Nov. 2017, it was back at $29, trying to push through $30.
Click to Enlarge
It did and here we are today teetering above $34. The recent rally is a little rich for me. Perhaps with all the enthusiasm around retail, Black Friday and Cyber Monday, GPS stock won’t come down much.
I would wait for a pullback to $30 and buy GPS stock at this level. We’ll know right away if it will hold and head higher or fail and break lower. With a stop-loss just below, we have a favorable risk-reward setup.
The problem with buying now? If it returns back to $30, we’re talking about a more-than 10% decline. This would actually be a healthy pullback, if it materializes. I can’t speak for others, but if I’m going to invest in a “healthy” setup, I’d rather do so without a loss.
The Bottom Line on GPS Stock
In a nutshell, we have a retailer that did pretty good numbers in 2017 and the expectation is for slight growth in 2018. If management can turn in mid-single-digit growth instead of low-single-digit growth, Wall Street will be cheering.
Further, shares trade at almost 16 times 2018 estimates. 16 times isn’t cheap necessarily, but it’s definitely not expensive. If GPS stock were to pullback to $30 though, it would trade at just 14.2 times 2018 estimates. That’s a reasonable amount to pay for a modest grower like Gap Inc.
Further, Gap stock pays out a 2.75% dividend yield. With a payout ratio of just 42%, little debt and almost $1 billion in trailing free-cash flow, Gap Inc has plenty of room to boost its payout. A decline to $30 bumps this yield up to 3%. GPS stock isn’t bad at current levels, but it’s much more attractive on a correction. Let’s see if it pans out.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
