Is Gap a Compelling Investment Opportunity Now?

Gap has a lower valuation than both Abercrombie & Fitch and Ann. Its consistent share buybacks, relatively low valuation, and decent dividend yield could make it more attractive than its peers.

Jan 24, 2014 at 8:25AM

Since the middle of 2013, The Gap (NYSE:GPS) has fluctuated in the range of $36.70-$46.50 per share. The recent price of $38.26 per share values the whole company at only 12.8 times its forward earnings. Compared to its peers Abercrombie & Fitch (NYSE:ANF) and Ann (NYSE:ANN), Gap has the cheapest valuation. In addition, Abercrombie & Fitch and Ann have much higher forward earnings valuations at 14.9 and 13.7, respectively. Let's take a closer look to determine whether or not Gap is an attractive buy now.

Gap's two key growth drivers
For the full year, Gap expects to generate around $2.57-$2.65 in earnings per share which implies a decent growth rate of 12%. The full-year operating margin is expected to stay around 13% with square footage up about 1%. On Jan. 9, Gap predicted 2013 EPS at the high end of its previous forecast range. However, while comparable-store sales were up 2% in November, they stayed flat in December. Thus, Gap's share price has received downward pressure since then.

There are two key future growth drivers for Gap. First is international expansion. Gap has focused on growing the business overseas to reduce its exposure to the U.S. market, which has high competition. Recently, Gap has increased its store base in mainland China by opening 18 additional stores for a total of 73 stores in this market. 

Gap expected to end 2013 with 82 stores in China, including 10 outlet stores and 72 Gap specialty stores. Gap also looks for further expansion of the Old Navy brand in China, with the first store to open on March 1 in Shanghai.

Second, Gap seems to be quite aggressive in growing its direct-to-consumer business. In the period of 2009-2012, Gap's direct business experienced a compound annual growth rate of 20%. In fiscal 2012, the operating income from Gap's direct business accounted for more than 22% of its total business operating income. 

In the third quarter 2013, the company launched the "Reserve in Store" offer for all of its Banana Republic stores and 200 Gap stores, which allows customers to reserve up to five items online so they can try the items on in stores. Many customers do not feel comfortable buying clothes online because they can not physically try them on, so this new "Reserve in Store" function is a good idea because it mixes online convenience and customers' personal experience with the clothes in the stores.

Abercrombie & Fitch and Ann also grew their online sales at double-digit rates
Ann's e-commerce business has experienced double-digit growth as well, driven by the high traffic flow and conversion rates of both the Ann Taylor and LOFT brands. The company said that it has benefited a lot from the investments in digital marketing. In the third quarter, Ann improved its search engine optimization program and enhanced speed, navigation, and customers' online shopping experience. It also considers e-commerce a major growth driver as well. 

Abercrombie & Fitch, on the other hand, has been turning itself around to improve its overall operating performance. The retailer has focused on reducing costs and shutting down Gilly Hicks stores. Its e-commerce comparable sales have surged by around 25% for the past two months. In December, online sales represented as much as 25% of total revenue. Thus, Abercrombie & Fitch can concentrate on the e-commerce channel to drive future business growth

What makes income investors excited about Gap is its consistent cash returns to shareholders via both dividends and share repurchases. In the third quarter, the company distributed nearly $900 million of cash to shareholders by buying 20 million shares at an average price of $38.77 per share and paying an $0.20 per share quarterly dividend. Year-to-date, the company has distributed more than $1.1 billion to shareholders. Gap also announced a new $1 billion share buyback authorization. At the current trading price, investors can enjoy a decent 2.10% dividend yield with a low payout ratio of only 22%.

My Foolish take
Gap seems to be a good pick at its current price because of its relatively low valuation in comparison with its peers, consistent share repurchases, and decent dividend yield. Over the long run, it could deliver good returns to shareholders with its international expansion and growing online business.

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Anh HOANG 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.

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