If You Bought Gap Stock Below $10, It’s Time to Take Profits

The business media have raved about Gap’s (NYSE:GPS) June recovery. Up 41% in June, it’s easy to forget that Gap stock was broken before the novel coronavirus and it will be broken after.

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Here’s why.

All of Gap’s Businesses Are Faltering

It seems like years since Gap management called off the ill-advised spinoff of its Old Navy banner. However, it only happened in mid-January.

Last November, CNN Business ran an article with the headline Old Navy’s future is in doubt, which discussed the abrupt resignation of Gap chief executive officer Art Peck. Robert Fisher temporarily replaced Peck until the board promoted Sonia Syngal, the head of Old Navy, to head up the entire company.

That was in early March. A few days later, Old Navy’s chief financial officer became CFO for the entire company. It’s now up to the gang from Old Navy to fix everything that ails Gap Inc.

But is it worth saving?

Over the past five fiscal years (2015 to 2019), Gap had same-store sales growth in only one of those years (2017), averaging a same-store sales decline of 1.2% in this period.

As for Old Navy, the so-called “star child” of the Gap empire, it had same-store sales that fell from 6% in 2017 to 3% in 2018 to -2% in 2019. Those are hardly home run results at a time when retailers were generally performing okay.

Heck, even Athleta same-store sales growth declined from 16% in 2017 to 5% in 2019. It barely could hang on to the business Lululemon (NASDAQ:LULU) didn’t pick up because it was still refining its e-commerce experience. Well, that ship has sailed. Athleta’s value to the Gap is no longer anywhere close to where it was three years ago. Opportunity lost.

Retailers All Go Through Slumps

It would be one thing if Gap were merely suffering a temporary setback. Unfortunately, it has been on a downhill trajectory for many years. Here’s what I had to say about it in May.

“In fiscal 2019, Gap had sales of $16.4 billion. That means for every dollar of debt the company has $1.44 in revenue. But don’t let that fool you. The company’s current Altman Z-Score is 1.97, which means it could become distressed should business continue to deteriorate,” I wrote on May 4.

In two months, Gap’s Altman Z-Score has fallen to 1.50, which means it now is in what’s called the “distress zone,” suggesting it could go bankrupt in the next 24 months.

Yet, somehow, investors think Kanye West’s Yeezy 10-year partnership with the company is going to deliver Gap from failure to salvation. I don’t think so. The man’s going to be too busy running for President to focus on his side gig.

That said, Gap has made it very lucrative for West to make the partnership a success. If annual sales hit $700 million by fiscal 2025, he’ll receive warrants for 8.5 million shares. If those shares were somehow able to run to their all-time high around $50, it would be a $425 million payday over six years.

While the Kardashian/West clan has proven to be adept businesspeople, the Gap needs to spend a little more time and effort meeting landlord obligations rather than setting up trendy partnerships.

The Bottom Line on Gap Stock

In June, Brookfield Property Partners (NASDAQ:BPY) filed a suit against the company, arguing that it’s failed to pay $2 million in rent and that it’s refusing to open its stores in the state of Texas where the suit is filed.

“For three months running, Gap has failed to pay rent at virtually every Brookfield location nationwide, even for stores that Gap is operating,” Brookfield stated in its court filing. “At present, Gap has withheld more than $2 million in rent from Brookfield in Texas alone.”

Other landlords are suing the company over its failure to pay rent, including Simon Property Group (NYSE:SPG), the world’s largest mall owner.

Yes, I realize Nordstrom (NYSE:JWN) has also gotten in on the act of failing to pay rent, stating that it will only pay half its rent for the remainder of 2020.

Interesting. Two family-controlled businesses. Two deadbeat tenants.

If you can’t meet your obligations, file Chapter 11 like many other retailers, and restructure your business. Of course, that would mean the two families would have to give up control over their retail empires and get real jobs.

If you were fortunate enough to have bought Gap stock below $10, I would consider taking profits. Gap’s future viability is very much in peril.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2020/07/if-profitable-time-to-sell-gps-gap-stock/.

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