Are all brick and mortar retailers going out of business? Reading some of the frenzied news coverage over the past year, you’d think so. But I’d argue the winnowing of the field is creating opportunities for the survivors. With weaker peers being liquidated, the strong have the opportunity to consolidate their position. And make no mistake, The Gap, Inc. (NYSE:GPS) is one of the winners. In fact, GPS stock is up 15% over the past year, while so many other mall players have fallen victim to the retail apocalypse.
But will the good times continue for GPS stock? So far this year, the stock is down 12%. And it recently got downgraded by KeyBanc, which said GPS stock was fully valued. Is it time to take profits or does The Gap have more good times ahead? Here’s what you need to know about the company:
GPS Stock Cons
Malls Continue to Struggle: Gap is an iconic American mall retailer. Unfortunately for the company, younger Americans don’t have the same affinity for malls that the previous generation did. Department stores are rapidly failing. 2018 has already brought a fresh bankruptcy (Bon-Ton). Once malls lose their anchor stores, traffic tends to drop off dramatically, hitting the interior retailers such as Gap.
Sure, malls aren’t going away entirely, particularly in areas where climates get extreme, making outdoor shopping centers unpleasant. But as malls continue to lose their appeal, retailers that thrived in them in the past will face a persistent headwind.
No Growth: 15 years ago, Gap sold $15.9 billion of clothing. Last year, Gap sold $15.9 billion of apparel. That’s literally no growth over a gigantic time period. Even based on inflation alone, you’d expect sales to be nearing $20 billion by now. Instead, sales peaked at $16.4 billion in 2014 and are now declining again.
GPS stock bulls will point you to the company’s increasing per-share metrics. For example, revenues are up 8% CAGR per share over the past 10 years. But that’s simply because the company has bought back a ton of its own stock. Unless the declining mall trend ends, it’s hard to see a path to much growth for Gap going forward, apart from financial engineering.
Some Stores Open, Others Close: Bulls are pointing to the opening of 200 new Old Navy stores as a sign that Gap still has opportunities. They’re correct. But realize this is the company accommodating a change in retail behavior, not a sign of secular growth.
The clothing industry continues to grow at an anemic pace. The pie isn’t expanding, just shifting. And newer entrants, such as fast fashion, are taking market share. This leads to what Gap planned last year — the intention to open 270 Old Navy and Athleta stores, while closing 200 Gaps and Banana Republics. Certainly it’s good that management is reacting to the changing environment, but this sort of lateral move doesn’t necessarily bode well for GPS stock.
GPS Stock Pros
Old Navy Doing Well: Part of Gap’s strength is that it has multiple strong brands. This really differentiates it from retailers that have only one concept. Gap is thus able to adjust to changing consumer preferences.
While malls indeed are in decline, Gap can react. We’re seeing a shift toward more value-conscious consumers, and that bodes well for Old Navy. Gap intends to open 200 more Old Navys in coming quarters. This should allow the company to at least maintain its revenues as it closes stores from its other brands. And the turnover in the store base may lead to higher profit margins as Gap realigns its offerings for changing consumer tastes.
Cheap Stock: One of the first things that would draw investors to GPS stock is its cheap valuation. After the recent sell-off, shares are down to 13.5 times trailing earnings. And that’s before the tax cut magic fully kicks in. Analysts see earnings per share going up to $2.76 next year, taking the forward PE ratio down to 11.
But, you might be saying, there are a lot of cheap retail stocks out there lately — Amazon.com (NASDAQ:AMZN) has crushed the whole sector. And that’s a valid concern. However the company has several advantages against similarly valued peers. For one, its multiple brands allow it flexibility in the fast-changing retail world. On top of that, Gap has a reasonably strong balance sheet, holding a sizable cash position and just $1.2 billion in long-term debt against sales of $15.9 billion last year.
Attractive Dividend: GPS stock offers one of the more attractive dividends in the retail stock arena. GPS stock is currently paying a 3.2% dividend yield and management just raised the dividend per share from 23 cents per quarter to 24.25 cents per quarter in March. That extends Gap’s prodigious history of dividend increases. Over the past five and ten years, Gap has raised its dividend by 11% per year (13% per year compounded).
With the payout ratio in the 40s, there’s more room for dividend hikes in future years. Adding to that, Gap’s management aggressively repurchases the company’s stock. As recently as 2012, there were more than 500 million shares of GPS stock outstanding. Since then, they’ve cut that figure by more than 20%, getting the share count down to 389 million recently. An aggressive share buyback combined with a rising dividend can lead to wonderful returns for shareholders.
GPS Stock Verdict
The bear case for The Gap, Inc. is easy to understand. The decline of malls is a visceral experience. Walk around in a slumping one, and it’s easy to want to give up on the whole concept of mall retail as an investment concept. But that reaction might lead investors to overlook a lot of good value stocks.
GPS stock is well up from its lows last year. There could still be more value here, though. With a greater-than-3% dividend yield, strong stock buyback program and 11x forward PE ratio, there’s an awful lot to like. Expect more ups and downs as the death of retail story continues to scare investors. But, over time, I expect GPS stock to see more good than bad developments in coming months.
At the time of this writing, the author had no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
