Gap Gets Off to a Rough Start in 2014

When the market opened this morning, Gap (NYSE: GPS  ) fell back below its Jan. 1, 2014, price. Last night, the company announced its March sales results -- they were not good. Comparable sales at all three major brands -- Gap, Old Navy, and Banana Republic -- fell compared to March 2013. That follows on the heels of a series of falls in February as well, putting Gap in a deep hole for the beginning of its fiscal year.

Until a rough turn in the third quarter last year, things were looking OK for Gap. Comparable sales were broadly on the rise before taking a turn for the worse. So what's going on at Gap that's dragging the business down, and is there an end in sight?

Let's go to the mall
Mall traffic is falling like a woman with her high heel stuck in the escalator -- right on its face. As shoppers move away from malls and those malls shut down, more and more business is moving online. Gap is chasing that shift, offering customers the ability to shop online and pick up in the store. That cuts down on shipping costs, and helps Gap meet its customers where they're actually shopping.

On the other hand, Gap still has over 3,000 largely mall-based stores in its network. Green Street Advisors, a real estate analysis firm, forecasts that 15% of U.S. malls will close or convert in the next decade, while some analysts are calling for even deeper falls.

Gap is trying to cut its dependency on malls, but it's a long road. Last year, online sales jumped 21% but still only accounted for 14% of total sales.

Getting outside of the traditional mall
Retailers who exist outside of the mall have had better success. VF Corp.'s (NYSE: VFC  ) North Face brand sells through other retail outlets and runs stores largely outside of the mall. In the company's last quarter, North Face managed to increase direct-to-consumer sales by 32%. Even VF wasn't immune, though: The company said that in the U.S. the retail environment for department stores led to weak results last quarter.

Gap's only real non-mall locations are at outlet malls, which are still malls. Gap owns 525 outlet stores globally and is pushing for growth. Those outlets represent an important part of the company's long-term strategy to diversify its channel delivery. Online and outlet are going to be the two keys for Gap as the traditional mall continues to suffer.

Gap still has a lot of strength and even through the weak sales it's managed to keep margins steady with operating margin actually growing to 13.3% last year. The struggle of the failing mall is a struggle that Gap is going to have to confront at some point, and the order online system isn't going to be enough. At some point, the business is going to have to pare down its footprint. For 2014, investors should be looking for sales to at least level out, as the business figures out what it needs to do to thrive over the next decade.

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