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Falling for shares of Gap Inc. (GPS
) no longer means falling on a sword. After several years of frightening sales declines, the apparel retailer, which runs Gap, Old Navy, and Banana Republic clothing-store chains, seems to be on the mend. In the past year, it has made commonsense changes like returning to casual wardrobe staples at Gap stores, cutting sourcing costs, and renegotiating lease terms. Analysts agree that the San Francisco-based outfit, the largest among so-called specialty retailers, has managed to stop what had once looked to be a deadly spiral.
Top-line growth is expected to hit about 5% for the fiscal year, which ends next January. Sales at stores open at least a year, a key measure of retail health, have been increasing for several quarters. Profitability also is rebounding. In the first quarter, Gap's net profit margin of 11.5% was in the top fifth relative to the rest of the retail universe, up from a net margin of 4% in the same quarter a year ago, says Dave Malmgren, portfolio manager at Rockville (Md.)-based Rydex Funds (which holds Gap shares).
The stock, too, has stabilized. It's still far from the record $51 it hit in April, 2000, but shares are trading around a 52-week high of $18, as of June 6, and up 16% year-to-date. Retailing stocks overall have risen 10% in the same period.
UNANSWERED QUESTION. However, a continued advance looks difficult. "I don't see any identifiable catalyst for the stock to move any higher," says Eric Jemetz, senior equity analyst at New Amsterdam Partners. Wall Street is divided on the stock. Sixteen of 28 analysts rate it a neutral, while 11 give it a buy or strong buy. And Gap shares aren't cheap at a price-to-earnings ratio of 20.
The longer-term problem Gap confronts is one all maturing retailers face: After years of organic expansion -- and Gap had a spectacular run with new stores and new concepts -- what's the next leg of growth? Gap may not be able to shift easily from its current cost-cutting turnaround mode to a more expansive model. With $14.5 billion in 2002 revenues and 4,241 stores in a market saturated with similar options, the law of large numbers comes into play.
The unanswered question is where Gap's new growth might come from. Net store growth this year will be flat, the company has said. Though over the longer term it sees some new-store additions for Old Navy and, to a lesser degree, Banana Republic, the overall store base won't be able to get much bigger.
FULL RACK OF COMPETITORS. Gap has initiatives -- maternity sizes at Old Navy and Gap, more petite offerings, sharper focus on the Gap baby and kids stores, and some international expansion -- that should make incremental additions to sales. While they're not bad ideas, they also aren't grand slams. "The scale of [these efforts] would not be a quantum shift," says Fred Crawford, executive vice-president at Cap Gemini Ernst & Young, adding that online sales would provide another small lift to the top line (Crawford doesn't own shares, and his firm isn't currently consulting for Gap).
And now, the company that set the course for casual dress in the 1990s, faces a litany of competitors selling similar products -- including Abercrombie & Fitch (ANF
), Sweden's H&M, and even mass-market discounters such as Target (TGT
). Former Gap CEO Mickey Drexler is heading the revamping of another purveyor of preppy clothes, J. Crew.
One more lingering point of weakness is Banana Republic, the smallest of its three franchises. Its men's line has been particularly feeble, with May sales rising only 2%. Analysts hope Gap veteran Marka Hansen, who helped rejuvenate the Gap brand and was recently appointed to head Banana Republic, can breathe new life into the chain.
SLOW ECONOMY, FASTER SALES. Gap has certainly benefited from a rocky economy, in which consumers were more likely to pick up a $15 shirt than a $300 suit. And that pattern of spending on smaller, less expensive items likely will continue as the economy crawls back. Says Crawford: "The world has swung their way."
Even though Gap's new strategies, many of which were begun under Drexler, have been driving sales growth, gains likely will be modest in coming months. In April, same-store sales grew 20%. In May, they rose 10%. But these figures aren't as strong as they might seem, since sales declined 24% and 9%, respectively, in the same months a year ago.
Analysts expect Gap's same-store sales will rise about 4% for the second-quarter months of May through July. Third-quarter sales are expected to rise about 2%, about the same as in this period last year.
ON THE EDGE. Gap's management insists it's focused on producing growth concepts. "We're still early in our turnaround and development of long-term strategies," new CEO Paul Pressler said during a May 23 conference call for first-quarter earnings. Yet skepticism remains. "They've stopped and recovered a business that was in rapid decline, but is this a growth story?" Jemetz wonders.
And Gap's stock price already reflects most of the improvement. For it to rise, it'll take "a more specific announcement about long-term growth plans," writes Emme Kozloff, retail analyst at Bernstein Research in a recent research note. (Bernstein doesn't perform investment banking.) While Gap's revival is solid, a strongly forward-looking strategy might be needed before investors get any more excited.
Tsao covers financial markets for BusinessWeek Online in New York Edited by Beth Belton
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