Is It Time for Investors to Fall Into the Gap?

Gap Inc. recently reported first-quarter 2014 financials and sales results for May. This might be the time for long-term investors to consider the specialty retailer.

Jul 1, 2014 at 11:00AM

Gap, Inc. (NYSE:GPS) is a leader in the highly competitive specialty retail sector. The retailer offers consumers an array of clothing, accessories, and personal care products at its flagship brands including Gap, Banana Republic, and Old Navy. Moreover, the company is diversifying by moving into the sports apparel sector with its Athleta brand, where it will compete with the likes of lululemon athletica (NASDAQ:LULU) and Under Armour (NYSE:UA).

Gap recently reported first-quarter 2014 financials and sales results for May. While earnings per share seriously declined, revenues continue to hold steady and net sales figures for May 2014 announced earlier this month rose by 4%.

Although the company faces challenges from its rivals and weary consumers in a sluggish global economy, Gap's growth strategy and earnings guidance make the retailer worth considering for investors with a long-term view.

Gap's first quarter at a glance
Gap continues to be solid in a number of ways, despite the fact that EPS in the first quarter fell by 18.3% compared to the year-ago period. The company attributed the decline to the higher cost of goods sold and occupancy expenses as well as challenging foreign currency markets. 

Earlier this month, however, the specialty retailer reported a 1% rise in comps for the four weeks ended May 31, 2014, compared with 7% growth reported for the four weeks ended June 1, 2013. The results were primarily driven by sales at its Banana Republic and Old Navy stores, and net sales for the month totaled $1.27 billion, a 4% rise versus the prior-year-period sales of $1.22 billion.

"We delivered a positive comp to start the second quarter, building on last May's strong performance," said Glenn Murphy, chairman and chief executive officer.

Finally, Gap's quarterly online sales came in at $575 million, up 13% from the prior-year quarter. More important, the company affirmed its earnings guidance of $2.90-$2.95 per share for fiscal 2014. 

In sum, Gap plans on growing its e-commerce business domestically and increasing its retail presence in the global markets. And by diversifying into the sports apparel sector, the company is charting a course for long-term growth.

Obviously, the question remains whether Gap will be able to compete with an established sports apparel leader like Under Armour. But the recent and well-documented travails of Lululemon may give Gap a window of opportunity.

Lululemon's slip is showing
Some "modest" consumers and investors in the sports apparel sector may have grown accustomed to people in the public square donning yoga pants. But Lululemon's launch and subsequent recall of see-through Luon pants in March 2013 was too much for most people to bear (bare?), so to speak.

And this misadventure, along with a rocky financial performance, recently culminated in an executive shake-up. Furthermore, Lululemon's fiscal first-quarter earnings announcement on June 12 featured a 60% drop in profits to $19 million, or $0.13 per share, compared to $47 million and $0.32 per share in the same period in 2013.

While the company's revenue rose by an impressive 11%, comps were up by 1% compared to a 12% gain in the year-ago period. Lululemon anticipates a similar decrease in comps in the low-to-mid single digits in the second quarter. Finally, the company lowered is fiscal-year revenue guidance.

Whether this might be a case of Lululemon underpromising in the hopes of outperforming remains to be seen. But a bigger question is whether Gap will be able to take advantage of Lululemon's slip-up. Either way, the company's Athleta brand has a long way to go compared to an established player like Under Armour.

Under Armour going up
Under Armour's growth strategy combines serving professional athletes,and using this as an off-ramp to attract so-called weekend warriors. The company also intends to grow by opening new signature stores while forming alliances with professional sports teams.

Under Armour recently opened an apparel shop in the SoHo neighborhood of New York City. The specialty store rolls under the name "SoHo Brand House" -- the company's largest retail outlet so far.

Moreover, Under Armour is forming new alliances with professional sports teams such as the recently announced deal with Rugby Canada. The agreement calls for the company to outfit all senior and junior Rugby Canada teams.

In short, these alliances, along with Under Amour's "Brand House" openings, will enable the company to grow its global brand.

The Foolish takeaway
At this point, it remains to be seen whether Lululemon will right itself and get back on the road to earnings growth. And Under Armour is in a league of its own compared to Gap's Athleta brand. But the company is poised for long-term growth as it expands online sales, penetrates global markets, and slowly continues its diversification into sports apparel. So, it could be time for long-term investors to fall into the Gap.

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Kyle Colona has no position in any stocks mentioned. The Motley Fool recommends lululemon athletica and Under Armour. The Motley Fool owns shares of Under Armour. 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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