The Challenge in Store for Gap


By Heesun Wee It's lunchtime in Midtown Manhattan, and shoppers, mostly women, are rifling through racks and piles of discounted fall merchandise at specialty retailer Gap (GPS). From raincoats to khakis to sweaters, customers can easily walk out the door with several items -- for under $100.

Shoppers like the sale prices, but the heavy promotions are hurting Gap. Same-store sales were down 2% for August, the most recent monthly figures available. Things might have been worse, but promotions and advertising boosted performance in the second half of the month.

NEW CHIEF, NEW HOPE? Gap is in a slump, and it's far from certain that the 15-year Disney veteran who has been brought in to fix the ailing chain can work miracles -- at least not in the near term. Shares are around $9.50, not much more than half the 52-week high of $17.14 they achieved in May. On Sept. 26, Gap stock jumped to around $12 after the retailer announced that Paul Pressler would succeed Gap's longtime CEO Millard "Mickey" Drexler, who in May announced his retirement. Pressler, 46, is credited with extending Disney's brand, leading to growth at Disney Stores and theme parks in California, Florida, and abroad.

The pop in Gap shares that the new CEO sparked, though, was short-lived, and the stock is now trading at 29 times the Street's estimated earnings per share (EPS) of 31 cents for 2002. That's hardly a bargain, especially for an outfit with such a tough road ahead. Bullish analysts herald the appointment as part of a turnaround. However, most observers aren't expecting a quick fix for Gap -- or its stock price.

Before Gap can grow again, Pressler has to deal with several core issues. In particular, the retailer has too many stores that are too big, creating a merchandise glut as managers attempt to fill the vast spaces. Wary observers also point to Gap's balance sheet, notably debt that's higher than its peers. And then there's the challenge of revitalizing the outfit's brands -- its Gap, Old Navy, and Banana Republic stores. Sure, Gap's TV spots are catchy, but if soft back-to-school sales recently are any indication, Gap's retreat from more stylish apparel to basics like jeans and black slacks hasn't been a hit.

DELAYED PAYOFF. To his credit, Pressler has a consumer-focused resume. Before joining Disney, he was the marketing vice-president in charge of Kenner Parker Toys' during the late 1980s, when its Care Bears line was a runaway craze. But that was 20 years ago, and this is his first stab at running a retail outfit. "His background seems a little incongruous in terms of what I see as the biggest obstacles right now," says Kindra Devaney, an analyst who follows Gap for Fulcrum Global Partners. She has a neutral rating on the stock, a notch above the sell recommendation.

Pressler is navigating the retail learning curve as the crucial holiday shopping season gets under way. His appointment "is a positive development, but we think it's going to take a couple of years, two to three years maybe, to see a notable payoff," says Tuna Amobi, an analyst who follows Gap for Standard & Poor's. S&P has an avoid recommendation on Gap shares, one level above the sell rating. Pressler was not available for an interview, and Gap declined to comment for this article.

Chief among Pressler's challenges is the outfit's real estate dilemma, some analysts argue. The San Francisco-based business operates some 4,100 stores (across all three brands), with about 15% located outside the U.S. Canada, Europe, and Japan. And many of the stores aren't just big, they're huge. The average Old Navy store, at about 15,000 square feet, is nearly double the size of a Gap shop. The upshot: The retailer has to fill that space, all too often with commodity-like stacks of jeans, khakis, and shirts.

SHRINK TO FIT. Cavernous Old Navy, for example, always seems to be bulging with merchandise, with a floor often permanently devoted to discounted goods to boost sales. "With [an estimated] 37.4 million square feet of retail space, we believe Gap's overall chain size is too large and limits Gap's base," Thomas Weisel analyst Anne-Marie Peterson notes in a recent research report. This needs to shrink, she adds, "before it will see more meaningfully improved results."

Gap's near-addiction to expansion across its three brands has also come at a price -- higher debt. S&P's Amobi notes the debt-to-capital ratio is roughly 47%, much higher than those of its peers, which range from 20% to 35%.

Revitalizing Gap's brands is another hurdle. Management has said lifting Gap's image was one of the key reasons Pressler was hired. "We were compelled by Paul's track record and depth of experience in marketing one of the world's most beloved brands," Gap Chairman and founder Donald Fisher said in a prepared statement on Sept. 26.

MUDDLED BRANDS. The task may be simpler at Banana Republic, which accounts for 15% of total domestic sales, according to analysts' estimates. Banana Republic's "casual luxury" focus churns out urbane apparel and accessories in high-end fabrics like cashmere and suede: Think $100 wool pencil skirts.

Brand distinction, though, is trickier with Gap and Old Navy, which respectively account for 37% and 36% of total domestic sales. Both stores sell casual clothes, but Old Navy's goods are cheaper and cater to the entire family. But too many consumers have discovered that styles and quality at both stores can be similar. If a pair of pants looks about the same at both stores and Old Navy's version is more affordable, why bother with Gap?

The muddled brands and past merchandise misses have hurt results. In fiscal 2002, which ended Feb. 2, Gap reported a net loss of $7.7 million, 1 cent per share on an EPS basis, on net sales of $13.8 billion. Only two years earlier, it was pulling in net earnings of $1.1 billion, or $1.26 EPS, on net sales of $11.6 billion.

Pressler has his believers, and he joins the retailer with a positive track record. Emme Kozloff, an analyst with Sanford Bernstein, notes that Pressler has a reputation as a strong manager and team builder, with an inclusive management style that should help improve morale. But with so many big hurdles facing this specialty retailer, it likely will take some time before Gap turns sales around and its stock recovers to anywhere near its old heights. Wee covers financial markets for BusinessWeek Online in New York


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