Why Gap May Be Another Step Closer to Retail Oblivion

Gap's (GPS +0.21%) second quarter of 2019 was another big letdown. While its budget-friendly Old Navy banner has been propping up results for some time now, that changed in a challenging springtime marked by high inventory that necessitated heavy discounting. Not exactly the scorecard investors wanted to see heading into the back-to-school and holiday shopping seasons.

Despite the short-term hiccup, Old Navy remains the best of this apparel bunch, and its upcoming stock spin-off (after which Old Navy will be free to operate as it pleases) doesn't bode well for the leftover pieces. The Gap, which is now officially what everything besides Old Navy will be called post-break-up, could be in real trouble.

Traffic trend? More like traffic exodus...

Gap's stock is plumbing lows not seen since 2011, and it's easy to see why. Revenues have been stagnant the last few years, and trailing 12-month free cash flow (basic profits after operating expenses and capital expenditures are subtracted) has plummeted 68% over the last five years.

The reason? Comparable store sales -- a blend of number of customers making a purchase and average ticket size -- at The Gap's largest names have been in steep decline. The shopping mall locations are suffering from lower foot traffic and e-commerce competition, including online-only stores. The only reason Gap's total revenue isn't in all-out decline is that it's opening new locations, particularly in fast-developing Asia.  

Data source: Gap. YOY = year-over-year. Comps = comparable store sales. 

To be fair, despite the ugly performance across the board so far this year, management reiterated that it expects average comps across all of its stores to only be down by low single-digit percentages for all of 2019. The cleaning up and shrinking of the inventory via discounting during Q2 should help, but there's a clear problem. Gap and friends are facing big changes in the way consumers shop for clothes, and a myriad of competitors that understand those changes got there first.

It's going to be an uphill battle.  

Image source: Getty Images.

What's the bottom line gonna be?

Granted, Gap CEO Art Peck said on the Q2 earnings conference call that the company expects Old Navy to do well for the balance of the year. He said much of the comps decline was due to the aforementioned heavy discounting, and the value clothier has otherwise shone over the last few years. But until more details emerge regarding the separation of Old Navy and the new Gap (which will include Banana Republic, Athleta, Intermix, and Janie & Jack), this one should be avoided.

Data source: Gap. YOY = year-over-year.  

What's even worse about the bottom-line earnings figure is that it includes share repurchases Gap has been making. Earnings would have looked even worse otherwise. Good money spent in bad places -- especially when there are plenty of business changes needed to right the ship -- doesn't feel like a prudent move.

One thing does seem to be working: Athleta. Ten new stores were opened so far this year for a grand total of 171, and the chain hasn't even expanded outside the U.S. yet. Another 14 stores are expected to open by year-end, and the brand just entered its first professional athlete sponsorship deal with U.S. Olympic track and field athlete Allyson Felix. Maybe the new company should just dump the Gap name and go with Athleta, since it's the only thing that seems to be working?  

Post-divorce, investors may find that Old Navy's stock is worth a buy. But judging from the long trend of decline everywhere else, not even Athleta is offsetting Gap's pain, and shares should be avoided for now. Maybe the time away from each other will be good for both Old Navy and Gap, but unless something drastically changes, the latter is headed for an unpleasant fate already suffered by so many other mall-based apparel chains.