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Gap: It Rhymes With Something

I'm actually getting tired of having to blow the same old tune about Gap (NYSE: GPS  ) . I mean, here's a once-almighty consumer brand that continues to wither on the vine. Month after month of crummy same-store-sales numbers offers proof that it's losing ground to more focused competitors such as Abercrombie & Fitch (NYSE: ANF  ) , American Eagle Outfitters (Nasdaq: AEOS  ) , Urban Outfitters (Nasdaq: URBN  ) , and, probably, that little old lady's knitting shop around the corner from my house -- the one that sells dog sweaters and plant cozies.

Gap turned in yet another bad quarter this time around, beginning with sales that are "flat," but decidedly negative on the comps side, to the tune of (5%). If you think that stinks, you ain't smelled anything yet, my friend. How about a gross-margin decline of 4.4 percentage points? A net-margin decline of 3.9 percentage points? How about a stick in the eye? Yeah, that would hurt, too.

I won't presume to speak for my friend and colleague Philip Durell, who made Gap a recommendation for Motley Fool Inside Value some 10% ago. I still believe he's right in his belief that some kind of turnaround is likely to come someday. And I would have to agree that Gap's strong balance sheets mean it's relatively safe for investors who want to try and wait it out. Indeed, had any other retailer turned in the cavalcade of garbage quarters that Gap has put in, I think Mr. Market would have slammed it a lot harder. Pacific Sunwear (Nasdaq: PSUN  ) , New York & Co. (NYSE: NWY  ) , and others have been suitably -- if not quite sufficiently -- discounted for their dismal performances.

But not so with Gap, and that's precisely the problem. The valuation still hasn't adjusted to the ugly reality, which is why I continue to say I wouldn't touch these shares, not with rich Uncle Leo's wallet. Why would I pay up an enterprise value of 0.75 times revenues for a flailing retailer when there are other ghastly underperformers out there that would be quicker to turn around and sell for less?

My cash-flow valuation, based on a predicted $800 million this year and growing at healthier clip than Gap has been able to muster (free cash flow has been declining for years) shows the stubs being worth $16 today. I wouldn't buy them for more than $14. Here's why: Heads need to roll.

Management has performed terribly, and there's been no sign it will pull things together. July was supposed to be the turnaround month, yet investments in marketing and new lines are producing so poorly to date that the firm dumped its own guidance yet again, from the $1.25-ish range to $1.10-ish for the full year. At current prices, I don't think this company deserves one investor dime.

Gap is a recommendation of bothInside ValueandStock Advisor. A free trial will let you see a more sanguine view of the stock's potential.

Seth Jayson wonders when the board will finally haul the guillotine into Gap HQ. At the time of publication, he had shares of American Eagle Outfitters but no positions in any other company mentioned. View his stock holdings and Fool profile here. American Eagle Outfitters and Pacific Sunwear are Motley Fool Stock Advisor recommendations. New York & Co. is a Hidden Gems pick. Fool rules are here.

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Related Tickers

10/20/2016 4:00 PM
GPS $26.49 Down -0.02 -0.08%
Gap CAPS Rating: **
ANF $15.74 Up +0.29 +1.88%
Abercrombie and Fi… CAPS Rating: *
NWY $2.26 Up +0.03 +1.35%
New York and Compa… CAPS Rating: **
PSUNQ $0.00 Down +0.00 +0.00%
Pacific Sunwear CAPS Rating: *
URBN $33.64 Up +0.05 +0.15%
Urban Outfitters CAPS Rating: ***