Can You Do Better than The Gap?
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
According to Ryan Gosling in Crazy, Stupid Love we can all do better than The Gap (NYSE: GPS). Something happened over the years that diluted The Gap’s brand image and with it its margins, but more importantly, its reputation. What was once a clothing giant in the minds of consumers is now an also-ran playing a numbers game as opposed to one based on fashion.
But fashion is about how clothes make you feel and The Gap has moved away from being a premium brand that sets trends to a middle-brow one that follows.
The stock has performed spectacularly in 2012 on the strength of a structural refit of the company’s business model in terms of square footage, store closing and improving comps and it is up 36.2% on the year through June 1. This is the strength of CEO Glen Murphy, a supply chain, numbers guy. But fashion is not about numbers first, and that’s where any potential turnaround story for The Gap should begin and end.
Going inside 2011’s numbers an interesting trend reveals itself. For years Banana Republic was an anchor weighing The Gap down. An unfocused mess of a brand, Banana Republic got away from functional multi-purpose clothing and became a lifestyle retailer that was ultimately rejected by the marketplace. Their recent collaborations with outside designers creating exclusive lines has proven very successful, especially the Janie Bryant line inspired by the hit show Mad Men. Comps for Banana Republic shifted 14% between 2012 and 2011 from a negative 6% to positive 8%.
Old Navy, on the other hand, is a brand still focused on competing with Target and Wal-Mart for all intents and purposes. Comps were unchanged year over year with mild sales deterioration of 1%.
The Gap itself has positioned itself toward the middle-class, which in the U.S. is under the most extreme budget pressure since the beginning of the financial crisis in 2008. Unsurprisingly this is the division that will see the majority of store closures -- 21% of their U.S. footprint will be closing by the start of 2014.
Like a number of U.S. retailers, in a world where e-tailing is rising rapidly, The Gap is burdened with too much square footage chasing too few shoppers. Shopping malls are dying in the U.S. This trend is not just hitting retail hard -- virtual services are becoming the norm in a number of industries and is becoming an expectation rather than a novelty. Best Buy (NYSE: BBY) is closing 50 mega stores while opening up 100 smaller mobile-focused stores. While The Gap does 11% of their business online, it cannot compete at the price points its clothes are targeting (i.e., there is a mismatch between their overhead costs and the revenue potential of the clothes they are selling).
This mismatch is so bad they are nowhere near the top 20 in terms of revenue per square foot in the U.S. Best Buy is struggling to remake itself and it is currently ranked 10th. Athletic wear darling Lululemon athletica (NASDAQ: LULU) is the highest clothing retailer on this basis by a wide margin over the next one, Ralph Lauren Polo; bringing in nearly twice their revenue, $1,734 vs. $904. The Gap’s North American revenue per square foot is a paltry $294 across all brands. The Gap’s plan to close 200 stores is an admission of a serious problem and one that will not go away overnight.
The Asian Paradox
Part of The Gap’s plan is to approach Southeast Asia as a new path to growth, but with their brand image in the dirt they no longer command the same image and with that pricing advantage. Sales in Asia account for just 8% of their total revenue but grew at a 12% rate in 2011 year over year, to $1.18 billion. They have a strong presence in Japan with 150 stores and are seeking to expand their China presence to 45 stores from 15 by 2014. Revenue per square foot in Asia is a much more respectable $784.
Asians are extremely brand conscious, especially as they rise in status and wealth. While it is somewhat more acceptable for an American now to wear an off-brand knock-off of a famous brand, having become very cost-conscious over the past few generations, it is not acceptable for Asians. It’s so bad that in the urbane, young Vietnamese middle class having an iPhone 3 is looked down on, whereas in the U.S. having an iPhone is still very much a luxury. It is here as well, but the status consciousness is much higher.
I don’t see The Gap having that kind of brand appeal here in Vietnam or in my travels around the region. So, while sales are good in Japan, it is also an older population. In the younger markets, both economically and demographically, however The Gap has a much tougher row to hoe.
Trading at a current P/E of 16.2 in a fragile market, the stock is vulnerable currently to giving back some of its gains from earlier in the year. Turnaround stocks are generally given the benefit of the doubt when they first announce the change in direction, but the market tends to be more ruthless as time goes on. Management will have to continue producing increasing value and internal growth or investors will leave it thinking they can absolutely do much better than The Gap.
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