Why Should You Bet on this Outperforming Retailer?

Ash is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of The Gap Inc. (NYSE: GPS) have increased by 61.76% in the last year. It has added new brands Athleta, Piperline, and Intermix to its brand portfolio over that period of time. In its first quarter 2013 results, its comparable store sales increased by 2% and revenue increased by 7%, despite a prolonged winter. It has focused on square footage growth across all brands in new economies and markets. Its core brands will continue to play a key role in overall sales growth, and it will look for more margin growth through its direct-to-customers channel. Now, let’s discuss a few points in detail.

International expansion across the brands is part of the long term growth strategy

The company has square footage growth plans across the world to drive its long term growth. It has focused on emerging Asian economies like China and Japan for international stores growth. The Chinese market is one of the largest apparel markets of the world, with a growing population and rising income levels. It opened 30 stores last year in China and will add 35 more stores this year. It also has plans to launch its “Banana Republic” brand in China and open 15-20 new Old Navy stores in Japan. China is estimated to provide 1/3 of luxury market share by 2015 and will drive sales growth in the long term.

Direct-to-Customer sales will drive sales growth with omni-channel initiatives

Gap's direct business was the major growth driver for it in the first quarter this fiscal year, where its direct sales increased by 27% YOY. The online market in the US is a very big opportunity for retailers as it is going to double in size by 2016 from $45 billion in 2012. The company has taken omni-channel initiatives and invested in mobile and media technologies to attract customers. Its Old Navy brand has initiated “ship from store” in the 1st quarter. Meanwhile, Banana Republic will launch a “reserve in store” program, which enables customers to book products online and reserve the stock in a local store. It will continue to enhance customer experience in the online channel to attract more customers in the future.

Stores consolidation and new brands expansion in North America will help it to gain market share

The company has faced low productivity problems in North America because of the market cannibalization effect and high concentration of stores. It has taken steps of closing down underperforming stores, which has helped it to achieve 5% higher productivity level. It has increased the presence of its smaller brands Athleta, Piperline, Intermix, Gapkids and Baygap. It will also expand Banana Republic and open 30 Athleta stores in the US.

Peer Analysis

In the specialty fashion apparel segment of the retail industry, two of Gap's peers are Urban Outfitters, Inc. (NASDAQ: URBN) and Express Inc. (NYSE: EXPR). Urban Outfitters has focused on its online channel to drive its sales growth in last few years. It has plans to increase its online sales, and it expects to achieve 50% share in total sales in the long term. It has shifted its product mix of its Anthropologie brand to more sensual and elegant brands, and it has seen positive results from it. Urban Outfitter has increased its product assortments on the direct channel and it has benefited from high online sales growth. It will also look for square footage growth and increase its store base to drive sales growth.  

Express believes in offering value to its customers, but it has now focused on a simple message of lower price points. Its increased promotions will create pressure on margin levels. It has used its online platform effectively to drive its sales growth, with 48% growth last quarter. Its Canada expansion has performed well with new logistics partner and it will look for more international stores growth this year. It will also come up with outlet stores strategy with slightly different price points.

<table> <thead> <tr><th> <p>Companies<strong></strong></p> </th><th> <p>P/S ratio<strong></strong></p> </th><th> <p>Op. margin<strong></strong></p> </th><th> <p>1 Yr. Fwd. P/E<strong></strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>The Gap Inc.<strong></strong></p> </td> <td> <p>1.40</p> </td> <td> <p>14.21%</p> </td> <td> <p>14.84</p> </td> </tr> <tr> <td> <p>Urban Outfitters, Inc.<strong></strong></p> </td> <td> <p>2.39</p> </td> <td> <p>11.26%</p> </td> <td> <p>19.27</p> </td> </tr> <tr> <td> <p>Express Inc. <strong></strong></p> </td> <td> <p>0.95</p> </td> <td> <p>11.54%</p> </td> <td> <p>12.77</p> </td> </tr> </tbody> </table>

Source: Google Finance and Yahoo Finance

The Gap Inc. has reported the highest operating margin of 14.21% among the three mentioned peers with a 1 year forward P/E of 14.84. Urban Outfitters has the highest P/S ratio of 2.39, but the lowest operating margin of 11.26%. Express Inc. has an operating margin of 11.54% and the lowest forward P/E of 12.77.

Conclusion

Gap Inc. has a strong growth opportunity with international expansion plans in emerging markets of China and Japan. Its direct-to-customers channel will drive its comps growth with omni-channels initiatives. It has taken crucial steps of store closures and new brands expansion to increase its productivity levels in North America. Its overall perspective looks better for growth in the long term, which is why I recommend a “buy.”

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Ash Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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