Do Shifting Trends Spell Doom for This All-American Apparel Brand?

The days of influence from name-brand clothing lines are quickly becoming an outdated trend. As the next generation of consumers changes what they consider stylish, unique designs and affordability have become increasingly more influential than the name on the price tag.

Gap (GPS 0.77%)announced earlier this week that it will be closing 175 stores in North America. The namesake apparel store has struggled in the past several years with weak sales, while sister chain Old Navy posts some of the best growth in the industry. Will our market mavens cash in on Old Navy, or has another company in this space caught their eye?

A full transcript follows the video.

Dylan Lewis: Mind the Gap, on today's consumer goods episode of Motley Fool's Industry Focus.

Hi, Fools! I'm Dylan Lewis, coming to you from Fool HQ in lovely Alexandria, Va. I'm joined today by half man, half amazing Fool.com analyst Vincent Shen. Vincent, how you doing today?

Vincent Shen: How you doing, Dylan? Thank you for filling in today for Sean. I don't know where he is. Skipping on his IF duties.

Lewis: I feel like this is the podcast equivalent of meeting up with a friend of a friend for drinks. It's like, you do podcasts with Sean, I do podcasts with Sean, and now he's not here. So we have to do the podcast together.

Shen: Oh, yeah! That's exactly...

Lewis: So, what are we talking about today?

Shen: Today we are going to mind the gap. Yesterday Gap made a big announcement that they are going to close quite a few of their locations, largely in North America and U.S. Today, as we speak, they are going through an investor analyst presentation to talk about how they're restructuring, because the company has generally struggled in the past few years. Slumping sales, especially weak comps -- same-store comps -- and as a result they're trying to streamline the business.

They got a new CEO that started in February and he has this new vision for the company. What that's going to entail with their recent announcement? They're closing about 175 of their 675 stores in the U.S. That brings them down to about 500 total locations in North America.

Lewis: That's about 20% of their U.S. footprint right now, right?

Shen: Yeah. They have 300 additional outlet stores -- factory stores -- but they're not touching those.

Lewis: OK.

Shen: The thing is, since hearing this announcement, the analysts on Wall Street have been pretty bullish on it, because they acknowledge the fact that the company's not doing that well. A lot of their stores are in malls and other areas that are underperforming, so they can shed some of this dead weight in one fell swoop.

Lewis: Yeah. So the thought here is that the underlying business would be stronger because we're getting rid of some of these underperforming properties?

Shen: Yes. Some of the numbers that they threw out there for the actual dollar impact of these closings; they're going to lose about $300 million in sales. So, pretty significant, but they're going to incur about $150 million in write-offs and other charges as a result of the closings. They're expecting -- starting next year -- about $25 million in annual savings from their structuring as well.

In general, they're going to run a little bit leaner. They're also going to shed about 250 jobs between their bigger offices in San Francisco, New York, across the U.S., which is just part of this restructuring.

Lewis: So, I'm guessing this is a result of struggling in general -- business prospects not being fantastic here in the U.S. Is that right?

Shen: The way that I've thought about it is; it reminds me a bit of the fast-food industry in that you had your staples. Like, McDonald's and Burger King and Wendy's. Now they're falling off the map a bit and falling prey to the new competition, which is a little better, a little trendier, more popular with younger millennials. Like, Chipotle, Shake Shack; they get these really high valuations. When I was growing up, Gap was the uniform of the 1990s.

Lewis: Yeah, I feel like that was -- the Friends cast; that's all they wore.

Shen: Exactly. So they really catered to this image of the clean button down, khakis. Now there are other options, and younger shoppers have shown a desire to create their own image. Something unique, something that touches on their own personality. So some of their competitors -- you can call them the "fast casuals" -- are companies that we'll talk about later. H&M (HMRZF -6.55%), Urban Outfitters (URBN 2.08%), Uniqlo from Japan, which offer this trendier, edgier fashion. That's what people are looking for.

Lewis: When I think about that era of retailers -- the '90s, and early 2000s -- the very successful apparel companies, Abercrombie and Aeropostale come to mind. They are heavily branded clothing, for the most part. My thought was that they would get dinged a bit by the normcore trend, and things moving to this "unbranded" or more minimalist style. So it's interesting that Gap is this classic look that you'd think is trend proof and they could navigate under the waters. What have they been doing to address consumer taste moving that way?

Shen: I'm glad you brought that up because the brand thing is losing its luster. Whereas before, heavily branded clothes like Hollister, Abercrombie, Gap; people just knew "that's Gap clothing." Now it's as though they're really focused on the item itself, and the brand, or who it's made by is no longer significant. This is why a company like -- you walk into a store like Urban Outfitters and they sell clothing from a lot of different makers.

It's ultimately that product focus. Although Gap and Banana Republic have both been struggling -- and that's two of Gap's three main businesses -- the last one, which really surprised me -- granted, I haven't shopped there in quite some time, since I was kid -- was Old Navy. Old Navy was originally thought of as Gap clothes, similar quality, similar look, but a more budget target group for the customers. It was really popular in the Midwest, across these malls, and they opened a ton of stores through the early 2000s.

They were very successful, but then that also ran into a slump. Now what happens is, H&M -- a company that launched right around that early time -- that's when Old Navy started seeing a decline. Somebody I think they probably hated at the time was this guy named Stefan Larsson who worked for H&M, launched a ton of their stores in the U.S., and allowed it to become as successful as it is today.

They poached him in 2012 and they basically said, "Old Navy is our struggling brand that we want to redefine. Can you do that for us?" In the past three years he has successfully turned it around. Now Old Navy's the star in the Gap profile.

Lewis: Yeah. I was surprised to hear that. I think a very visible way to look at that transformation is -- when we were prepping for the show earlier we were looking at the websites -- and I went to the Old Navy website for the first time in a year and half. It looks almost exactly like the Urban Outfitters website in terms of its layout, the graphics they're using, the stylized font; it's very similar. So you can tell who they're going after there.

Shen: It was really interesting how Larsson approached this turnaround. He basically wanted to do this from the ground up. He even had the corporate headquarters for the Old Navy team completely redesigned. So instead of looking like -- I think they described it as looking like a hospital office -- they've made it a little trendier. Just bringing this image throughout the entire company; from the ground up.

Instead of trying to sell these last-season designs for cheap, they want to actually focus on the product itself. Make the product -- even that Old Navy's selling at their lower price point -- something that's trendy, and something that people actually want to wear.

Lewis: It sounds like there's been a lot of success with apparel companies hitting those lower price points. You were talking about margins a bit when we were prepping for the show and I was totally astounded. You were saying H&M has these ridiculously gaudy margins.

Shen: Yeah. Urban Outfitters, Gap, a lot of the other retailers in this space; I think their gross margin is right around 35% to 45%. H&M -- which I've always already thought of as this budget retailer, clothes already being cheap -- they have some of the best margins in the industry. Gross is around 60%.

Lewis: That's kind of crazy because I would assume they made it all up on volume and had razor-thin margins based on their prices.

Shen: Exactly.

Lewis: And they sell T-shirts for $5 or $6.

Shen: They clearly have done very well keeping their costs down, and allowing themselves to reap the profits there.

Lewis: OK. So, seeing where the industry's going, seeing what's working right now in terms of Gap's holdings; how do things look for Gap's namesake brand itself?

Shen: I think, like we talked about, some of the store closings and the announcements that they're making right now are surely going to point to this picture of where they'll run a bit leaner, they're going to focus again on putting out styles that -- they had this new slogan last year that was, like, "Dress normal." They launched an ad campaign off of it and they were hoping that it would provide them a push during the holiday's sale season. It didn't work out that way.

So I think, right now, it's almost like a ship without a captain. They're trying to find this vision, and part of that is going to be redefining their image with consumers so they no longer think about it as a place where they get the kind of outfit everybody else has. It's something a bit more unique, because that's what the consumers are asking for. Until then, it's not like it's all cloudy skies for the company. Like I said, Old Navy's doing really well.

They also acquired the Athleta brand and for retail that has been a positive trend where people are -- sports apparel is just very popular right now. Hence, the rise for companies like Lululemon(LULU 0.80%).

Lewis: Yeah. For our listeners, Athleta is very similar to Lululemon.

Shen: Yes. Just to give you an idea of that; Gap's been closing stores almost every year. This is their biggest announcement recently. But for the past two years at least -- actually, since they acquired it in 2012 -- they've opened 90 stores in the U.S. So it's definitely a big push for them. Also a big push for them is in China, and Asia in general. They're really expanding their presence and it's like you're harking back to a time where -- shopping malls in the United States are at a decline -- e-commerce is hitting into that and for a lot of shoppers those are more attractive places to go shopping.

In China and Asia, where the middle class is really emerging now, they're seeing huge shopping malls being opened up because this is their time now. So that's why some of the biggest malls in the world are now opening in China. Gap is seeing the opportunity to expand there.

Lewis: Yeah. I think that's a very important distinction to make. Everything that we're talking about in terms of the recent developments -- with the store closings -- is specific to the U.S., and the Asian markets provide a huge opportunity.

Shen: Yeah. And some of the closings recently announced might be in Europe, but overall the big hit is in North America. There are definitely going to be opportunities for the company, and I think they'll definitely focus on that in terms of their growth trajectory; being in other regions. In the end, Gap's their namesake business, and they need to get that right in a very significant market for them -- their biggest, really, being North America.

Keeping that in mind with the Old Navy brand, some of their double-digit sales earnings growths are really impressive; but even that has started to slow down a little bit. We all know that the apparel retail industry is ultra-competitive. So that's a bit of the environment that they're in. E-commerce is rising up. At this point, I think it has doubled as a percentage of total retail sales in the past few years. That's the climate they're in.

Lewis: Yeah. Well thank you very much for your time, Vincent.

Shen: Than you, Dylan. Appreciate it.

Lewis: Happy to have you. That's it for us, Fools. But before we go, I wanted to make our listeners aware of a special offer. If you found this discussion informative and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner. We're offering the lowest price out there for our Industry Focus listeners: $98 for two a two year subscription to Stock Advisor.

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