Can Gap Improve in the Long Run?

The fiercely competitive environment in the apparel retail industry took a toll on Gap  (NYSE: GPS  )  in the first quarter, as its net income declined 22% year over year. The company's Gap and Banana Republic apparel brands got off to slow starts in the spring selling season, and improper inventory management hurt its bottom line. Despite the setback, the company reaffirmed its full-year guidance.

However, can the company get back on track in the face of competition from American Eagle (NYSE: AEO  ) and Urban Outfitters (NASDAQ: URBN  ) ?

Improvement is in the cards
According to management, Gap's business improved toward the end of the first quarter. Glen Murphy, Gap's CEO, is confident that the company's strategies will drive long-term value for shareholders. Gap believes that it can bounce back after its net income dropped for the first time in two years.

The company had not marked down its excess product adequately in the first quarter, which led to inefficient inventory management. Having learnt from the mistakes committed in the first quarter, it is now taking corrective measures. Gap is focusing on product assortment, customer communication, and inventory to improve its business. 

Brand strength
Gap's Old Navy brand did well in the first quarter, and the company expects the momentum to continue going forward. Gap got the assortment right for Old Navy, with a focus on fashion essentials. Old Navy has a robust creative platform, and its designs clicked with customers. As a result, the Old Navy brand posted comparable sales growth of 18% in April, and the company expects the trend to continue. 

The retailer is also positive on the future performance of Banana Republic. Gap hired Marissa Webb as the creative director of Banana Republic, and believes that she will bring a fresh perspective to the brand. Gap will be revamping its social media initiatives for the Banana Republic brand, and expects its moves to deliver results by August. 

Growth-oriented moves
Gap's priorities include store growth, omni-channel initiatives, a responsive supply chain, and seamless inventory. It has opened 250 new stores this year that include both corporate and franchise stores. Its Chinese expansion plans are also on track. The company plans to open stores in 20 new cities this year in China.

It will also continue to expand its Athleta brand. Gap plans to open 35 new Athleta stores in the US this year, bringing the total count to 100. Also, it intends to open 60 new Athleta outlets globally to sustain the pace of its international growth. 

Gap is also stressing omni-channel distribution. The company's "Reserve in Store" initiative has been rolled out to 500 Gap stores, and it will now test out "Order in Store". The Reserve in Store initiative enables shoppers to book merchandise online and then pay for and pick up the items at Gap stores within 24 hours. This has been well-received by customers, and now the company is thinking of testing Order in Store in select stores. 

Order in Store will allow customers to order products from the company's online catalog inside its store locations. With this move, Gap will integrate e-commerce with its physical store locations. The company needs to make these moves in the omni-channel category because American Eagle and Urban Outfitters are giving Gap tough competition in this area.

Competitors' moves
American Eagle, for example, intends to open new distribution centers this year. This will result in a single pool of inventory and lead to robust efficiencies across its supply chain. The company will be able to fulfill orders more quickly and efficiently with new distribution centers. American Eagle will also open more physical stores this year, and outlined a budget of $230 million to expand the business. 

Urban Outfitters, meanwhile, has been consistently ranked among the top 50 e-commerce firms by Internet Retailer.  The company's e-commerce platform is driven by robust analytics and reporting, which allows it to personalize its website for each visitor. Urban Outfitters focuses on different areas of e-commerce such as email acquisition, product recommendations, shopping cart reminders, and geo-targeting to maintain its strong position. 

Hence, Gap will need to invest aggressively in its e-commerce business to close the gap with Urban Outfitters.

Final words
Although Gap started the year poorly, management is confident that the company will get better going forward. The company's stock trades at a trailing P/E of less than 16, so it is much less expensive than American Eagle at 36 and Urban Outfitters at 19.  Gap's forward P/E is also impressive at 12.6, which signifies expected earnings growth. Finally, Gap also pays a dividend that yields 2.10%. Investors should look at its long-term prospects rather than its timid performance in the first quarter.

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