Why Is Gap Spinning Off Old Navy?

Gap (GPS -1.28%) has been closing stores while its Old Navy brand has plans to open around 800 new locations. That's partly why it makes sense for the parent to spin off the brand as its own publicly traded company.

In this segment from Industry Focus: Consumer Goods, Fool.com contributor Daniel Kline joins host Dylan Lewis to discuss why Old Navy has succeeded while Gap has struggled.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Oct. 8, 2019.

Dylan Lewis: I think Gap was the retailer of the '90s. Right? That's what everyone pictures when they're picturing the cast of Friends on the couch in the coffee shop. It was such an iconic brand.

Why don't we switch over and talk about Old Navy and Gap? When you're thinking Old Navy, the dynamic is similar with the parent company. But this is a brand that operates in a totally different space when it comes to consumer spending.

Dan Kline: These are much more differentiated brands. I actually like Old Navy as an investment more than I do Madewell for one reason -- yes, Old Navy is doing fashion. On some level, they have to hit with customers. On the other hand, as a parent, there is an age where your kids don't care about fashion. For me, it was up until about 10. My son didn't care. Then he started to really care. You're just like, "I need pants." Old Navy sells cheap pants that are reasonable quality. They sell jeans that, for an adult are somewhat disposable jeans, because they wear out; but for a kid who's growing quickly, that doesn't matter. So the sustainability of Old Navy, because it can sell to younger age groups, or even just, "I'm trendy for most of my clothes, but I just need a cheap hoodie because it's going to be cold," there's a very defensible part of that business.

Gap really hasn't changed its menu. It still sells a lot of denim and things that are just not at the moment all that popular. They haven't really been able to pivot. Part of that is because they do own other brands and those brands have staked out different territory that have prevented Gap from going there. Again, this needs to break off. Old Navy's literally going to open 600 to 800 stores going to markets they haven't gone into. I'm fairly bullish on that prospect.

Lewis: Yeah. Some of the other brands under that Gap umbrella -- we have Banana Republic, and I believe Athleta as well. Right, Dan?

Kline: Yeah. Athleta has been a mild success story, but it's not that much of a stand-alone brand the way Old Navy -- who doesn't know Old Navy? Old Navy has giant stores. Whereas Athleta is more of part of the Gap brand. Banana Republic has its own problems. It's a high price point, maybe even a little higher than Gap, with a diminishing return. This is a case where, you are getting Old Navy, which is growing quickly and has the ability to expand at a time where its size of store is something retailers are desperate for -- they will be able to go into any community, look at any shopping plaza, whether it be a mall, or in their case, they have a lot of off-mall locations -- and somewhat name their own price because there aren't a lot of people opening 20,000 to 40,000 square foot stores. There are a lot of vacancies. That's basically one floor of a closed Sears, and a lot of malls have closed Sears. You could put, say, office space or a gym up top, and an Old Navy, and your problem is solved. So there's really big potential.

They've managed to keep their clothing semi-fashionable -- I don't think anyone thinks of Old Navy as all that hip -- for 20 years. It's really been a long time where this has been an acceptable default, nobody's going to mock you too badly if you're wearing it kind of brand.

Lewis: And they've always managed to be affordable. There's a clear difference between Old Navy and Madewell here. You're thinking about buying clothes for your family or something like that, it's a lot easier to be like, "OK, we've got a young kid," or, "I'm going to be wearing this around the house while I'm hanging out with my young kid, and yeah, it'll probably get stained, so I'll spend $10 or $20 on this shirt rather than $50 or $60 on a very well made shirt from Madewell that is probably going to get tomato sauce on it at some point."

Kline: Yeah, and it's important to note, Old Navy contributed 85% of Gap's profits. It's clearly doing its work. And as a parent, I can tell you, I don't spend that much money on clothes. You joke that I wear a uniform. I do. I own a billion of this shirt. I live in a hot climate, so I wear a T-shirt most days. But when I lived in a Northern climate and needed cold weather stuff, I shopped at Old Navy quite a bit. I work from home alone. I don't need to impress anybody from a fashion point of view. Just buying a sweatshirt to wear around the house or to go to Starbucks or whatever, it just wasn't that important. That's always going to be a niche for Old Navy that, even if the fashion part of its brand falls off, and the 17 to 22 year olds think the brand is really uncool for a while, that's OK because Dad's always going to be uncool, and kids below a certain age have never cared about cool. At its height, maybe Target is equal. But generally, I'd say Target's a step below in terms of brand perception. It's a very smart space. It's a company that has been putting up big growth, but some of its proceeds have gone to cover for losses at its sister brands.