There Are No Gaps in This Retailer’s Performance

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

Gap (NYSE: GPS) is easily one of the better performers in the apparel retail industry. The company has kept investors happy with stock price appreciation of 37% in past 12 months, along with a small but safe dividend that yields 1.5%.

Gap, in fact, has this ability to keep its earnings per share moving north even with moderate financial performance. Over the last five years it has clocked a compounded annualized EPS growth rate of 17%. With its well-planned growth strategies, that momentum should continue.

Profit never goes out of fashion

Gap substantiated this amply in its first quarter. Net sales were up 7% to $3.73 billion, lapping up a 5% increase last year. Same store sales were up 2%, buoyed by the namesake brand and Old Navy, both of which grew 3%.

The company grew its earnings by 51% y-o-y to $0.71 per share. This is impressive even after factoring in the tax gains and seasonality, and more so if we consider how some of Gap’s peers fared.

Abercrombie & Fitch (NYSE: ANF) reported a 15% decline in same store sales, and net sales declined 9% to $838.8 million. Although it improved its bottom-line performance, earnings are still in the red at a loss of 0.09 per share. The company is facing problems with inventory management--last year it had excess, and this year it didn't have enough to generate top-line growth.

Teen retailer American Eagle Outfitters (NYSE: AEO) also witnessed its same store sales plummet 5%, while total revenue decreased 4.1% to $679.5 million. Adjusted earnings declined from $0.22 per share, a year ago, to $0.18 per share in the current quarter. While the company cited weather and economic weakness for the fall, the underlying fact is that it is bowing down to competitive pressures.

Gap is deepening roots in domestic markets

Granted the US apparel sector is mature and does not offer rapid growth opportunities. But given that Gap’s share is just 3.9% in this $300 billion market, it is still possible for the company to grow its market share. Management believes that 4.5% is achievable.

Gap is leveraging its brands optimally. It is maximizing gains from its flagship and other mature brands like Banana Republic and Old Navy by investing in omni-channels, closing non-profitable stores, etc. On the other hand, it is expanding its smaller brands like Atheleta, Piperlime, and Intermix.

With free cash balance of $1.6 billion there is no dearth of funds to propel these initiatives. None of Gap’s rivals have similar cash balances to pour in growth initiatives. Abercrombie has around $555.9 million, while American Eagle has some $383.2 million.

Opportunities for smaller brands

It is a good time for Atheleta and Gap Kids to increase market share. Atheleta’s rival Lululemon is witnessing public wrath over its see-through ‘yoga pants’ and child labor issues, while American Eagle has discontinued its '77 kids’ brand, making it easier for Gap Kids.

Gap has created solid platforms for leveraging these opportunities. It has transformed Atheleta from a catalog business into an integrated brand with 35 physical stores, with plans of adding 30 more through the year.

The company also fueled a lot of demand for Gap Kids last year with the launch of its first limited edition collection, where it partnered with designer Diane Von Furstenberg. It will launch the second collection this year.

There are good opportunities for Piperlime and the recently acquired Intermix. Piperlime will evolve from its online avatar and see addition of physical stores while Intermix, which has around 30 stores in US, will see both doubling of store count and an online platform to boost sales.

Omni-channel retailing

Omni-channel is the current retail mantra. Retailers are out to ensure that options are no longer limited by inventories carried at individual stores, and shopping is just a click away.

Gap already has initiatives like ‘ship-from-store’ and ‘find-in-store.’ In the first case, for any online order that cannot be delivered within two days from a distribution center, the nearest store steps in. This reasonably assures that buyers find their chosen goods always in-stock while the prompt deliveries minimize cancellations or missed sales.

In the second case, buyers can check the company website to know in advance if a particular item is in stock at a particular store.

Thanks to these initiatives, Gap’s online sales were up 27% in the first quarter. This was a significant achievement given that Abercrombie’s direct-to-consumer sales decreased 10%. American Eagle grew its e-commerce sales by 24%, but from a much smaller base.

However, Gap is about to launch its best initiative, reserve-in-store, later in the year. This will allow customers to reserve an item online, then go to a store, see it, try it on, and then buy it.

The beauty of this move is that it will increase footfall significantly. Customers who are reluctant to place online orders can now reserve the item and go to a store to check it out. Some may buy what they reserved and those who do not can always find something else.

Global expansion plans

Excluding US, the global apparel market is $1.1 trillion in size. Although Gap has around 300 franchised locations in 40 countries, it is vying for a bigger presence. China and Brazil are currently two focus areas.

China, with its 1 billion-plus population and growing western influence, is attractive for any retailer.  What bodes well for Gap is that the market is not yet congested with western brands. The company intends to have 80-85 stores in China by year-end.

Brazil, on the other hand, is Latin America’s largest economy and an emerging market. It too is relatively un-invaded by western apparel retailers, and Gap wants to be there before its peers. By fall this year, the company will open its first store in Sao Paulo, the largest city of Brazil.

Gap also has plans for Japan, Hungary, Mexico, Chili, Panama Columbia, Uruguay, Paraguay, and Peru.

Parting thoughts

Gap’s solid operating performance and growth potential in both domestic and international markets makes a bullish case in favor of the company. The frequent share repurchases and dividends are added perks. 

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Eshna De 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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