Does Gap Stock Have What It Takes to Move Higher?

Examining the pros and cons of GPS stock

Gap (NYSE:GPS) had a decent year in 2018. Gap stock did not. It delivered a total return of -21.6%. Year to date it is down 2.75% through this morning.

Can Gap (GPS) Stock Rally in 2019 Despite Its Headwinds?
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InvestorPlace contributor Vince Martin took a page out of the Dogs of the Dow playbook this past December recommending 15 stocks that lost money in 2018 which he thinks will deliver the goods in 2019.

One of Martin’s recommendations was Gap stock, which has been leaning hard in recent years on its Old Navy business. With two months in the books, GPS stock is going in the wrong direction, which begs the question: Does Gap stock have what it takes to move higher as we head into the spring?

Here are the pros and cons of owning GPS stock.

The Pros of Gap Stock

Old Navy: As my colleague so eloquently stated in his December piece, Old Navy is the engine that drives Gap, the company. Gap, the flagship franchise, might be on life support, but Gap Inc. is doing just fine because consumers continue to buy a lot of its modest apparel.

As Martin said, Old Navy generates about two-thirds of the company’s overall profits, it continues to deliver mid-single-digit same-store-sales growth and accounts for almost the entire $9.5 billion market cap of Gap stock.  

As long as Old Navy continues to perform, shareholders shouldn’t be concerned about GPS stock falling very far in 2019.

Banana Republic: I’m sure a lot of shoppers had forgotten about Banana Republic, but if the third quarter was any indication, it’s slowly pulling itself off the mat. In Q3 of 2018, Banana Republic had same-store-sales growth of 2% on a global basis, three percentage points higher than a year earlier. More importantly, as Banana Republic’s been closing stores, it’s managed to grow same-store-sales for four consecutive quarters, a testament to the brand’s staying power.

It might be down, but it’s not out.

The Dividend: If you’re an income investor, you might want to check out the GPS dividend yield. It’s currently 3.9%, considerably higher than many of its peers. In Q3, the company raised its quarterly payment by more than 5% to $0.2425 a share. Yet, it retains a low payout ratio of 38%, ensuring that it will have no problem continuing to increase its dividend.

Online Sales: In the span of three years, Gap’s annual online sales have grown from approximately $2.7 billion to more than $3.5 billion in fiscal 2018. During this period, Gap’s online sales went from 17% of its overall revenue to 21% in 2018. 

If you want to be a player in omnichannel retail, your online sales have to be more than 20% of your total sales. GPS meets that criteria. 

Athleta: If you’ve followed the success of Lululemon (NASDAQ:LULU), it’s not hard to see why Gap CEO Art Peck continues to focus on  the company’s athleisure brand. In the 39 weeks ended November 3, 2018, Gap opened nine net new Athleta stores; it now has a total of 157 of these stores. Athleta might not have the scale of Old Navy, but it’s vital to the future success of Gap stock.

The Cons of Gap Stock

The Gap brand: Gap’s legacy brand has been a noose around Gap Inc.’s neck for more than a decade. In the past 19 quarters, Gap’s had negative same-store-sales growth on 16 occasions. Its average same-store sales decline over that period has been 4.2%.

It’s not surprising that pundits wonder if Gap (the brand) should be killed off. I’ve long felt that Old Navy and Gap are too much alike, making Gap’s higher prices a real drag on its business.

Why go to Gap when you can get similar products for less at Old Navy?

The Gap brand and stores should be spun off or sold at this point because the odds of them remaining relevant are slim to none.

Old Navy: I’m not sure why anyone shops at Old Navy because its clothes are awful and its service is even worse. It might offer low prices, but you can get that from a lot of different retailers.

Consumers’ preferences continue to change. More people are opting for items that are better made and long lasting. Quality over quantity. As a result, Fast Fashion is losing its grip on the retail world.

In the U.K., a recent survey suggests that consumers are willing to pay more for items that will last longer, thereby avoiding a quick trip to the dump.   

“After years of shopping for trendy and – invariably – cheaper fast fashion, could consumers finally be making the move towards longer-lasting and timeless items?” Lee Lucas, principal of the Fashion Retail Academy, asked in a statement.

“This shift towards quality over quantity is surely a reflection of how customers are increasingly mindful of sustainability and the supply chain of clothes manufacturing – as well as acknowledging that more expensive price tags might mean more mileage from certain items of clothing.”

Gap’s moneymaker will be in serious trouble if consumers abandon Fast Fashion and lower prices.

The Bottom Line on Gap Stock

If it weren’t for Gap’s dividend, I’d be negative about Gap stock, despite the fact that I’ve listed more pros than cons about GPS stock.

Gap should have acted much sooner to grow its Athleta business. Now, I’m afraid that LULU has permanently captured a big chunk of the athleisure market.

As for Old Navy, I get that it wants to make hay while the sun shines, but ultimately, it could end up being another brand with a massive real estate footprint and fewer and fewer customers, much like Gap’s namesake brand. If that happens, the owners of Gap stock should look out below.

For now, if you want to earn the income from Gap’s dividend, I don’t see a problem owning Gap stock. Long-term, I’d be much less confident about GPS stock.

Gap is slated to announce its Q4 2018 earnings today after the markets closes.  

As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

 


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