Time to Jump the Gap
Kirk is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Sometimes your best research isn't the financial numbers, it is some alternative trusted source of information. Many times I follow the insider purchases of company stock or what hedge funds are accumulating like Insider Monkey does. Other times I turn to an expert in an industry to ferret out trends, as I have done with much of my oil company research. In the case of the Gap (NYSE: GPS), I turned to my 14 year-old daughter and her friends.
If I have learned anything about teenage girls from my daughter and her friends the past couple years, it is, they like what they like, and they don't spend money if they don't feel like they are getting a value. I know that's a lot like women in general, but forgive me if I try to fight off the transition of my daughter from "daddy's little girl" to woman.
In today's tight economic times, both preference and purchasing power are important. This isn't a go-go period where the money is flowing freely and a bad purchase can be replaced by another. As a result, there is very little room to spend a large part of the budget on something that does not offer a compelling value proposition.
In visiting the mall with my daughter and friends, while keeping a healthy distance, I watched to see what stores they went into and spent a lot of time in. The Limited (NYSE: LTD) seems to have brands that the ladies like in Pink and Bath & Body Works, as well as, uggggggh, Victoria's Secret (thankfully just for the perfume for now). Where the girls didn't go at either mall was Gap, or Gap-owned stores Old Navy or Banana Republic.
Out of curiosity, I had lunch at the malls near me a few times over several weeks and strategically sat myself with a good view of storefronts. Pink is clearly the teen girls' favorite store. Not only do they go in there as a rule, they come out with a bag very often.
Without looking creepy (and having told the mall police what I was doing), I watched groups of girls who came out of Pink to see if they went to Gap, Old Navy or Banana Republic. In most cases they did not. Traffic into Pink was at least three times that of the Gap stores, though America Eagle (NYSE: AEO) appeared to do quite well on the traffic/bag analysis as well.
An aside with American Eagle: now that they have issued a special dividend, which signifies some anxiety about the tax code. I am concerned about their growth and really, retail growth in general.
In looking at the numbers (yeah, I still do that) Gap assets have remained relatively constant the past year. Their revenue growth has lagged however at 5.6% versus the industry's 13%. It is important to know that their increasing margins have largely been due to refinancing of debt at more favorable terms. Margins will not likely continue to widen broadly, especially if we get more inflation as expected in the next few years.
With a P/E ratio of about 20 and a revenue growth rate of 5% to 6%, I believe Gap will miss PEG estimates, which average about 1.8 and are not low to begin with. With margins set to level off or contract, GAP, like much of the sector, carries a too rich valuation for me to commit money. In addition, there is little to no durable competitive advantage with any of the companies mentioned, and only the Limited seems to come close to clearing that hurdle.
Now, this is not enough to short Gap unless it spikes up again in price, but in my mind is probably enough not to buy it. In fact, the entire sector is suspect based upon realistic views of growth and some optimistic valuations. With most of the category, I am going to apply Charlie Munger's wisdom: “We just throw some decisions into the 'too hard' file and go onto others.”
Kirk Spano and clients of Bluemound Asset Management have no positions in the stocks mentioned above. Neither Kirk nor Bluemound clients plan any transactions in the next 3 trading days in the mentioned company's securities. Opinions subject to change at any time without notice. Follow Kirk on Twitter @KirkSpano or visit his firm website at http://BluemoundAM.com
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