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Near a 25-Year Low, Is Gap a Buy?

By Jennifer Saibil – Apr 24, 2020 at 7:52AM

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Are shares of this apparel retailer's stock a great opportunity, or a lost cause?

Once upon a time, Gap (GPS -2.15%) was a premium retailer, dictating fashion trends to its loyal customer base. The fairy tale has seemingly ended, and with the COVID-19 pandemic disrupting sales for many retailers and forcing the temporary closure of many stores, the stock is now near a 25-year low. That's a big loss for long-term shareholders of the company.

Can the share price recover and once again make this stock a buy?

Why Gap apparel sales, and stock prices, are down

Retail is in turmoil as COVID-19 continues to wend its way through global communities, and stores are mostly shuttered. Apparel-focused retailers have been particularly hard-hit, partly because consumers have switched to buying essentials. With record numbers of workers losing their jobs, money's being rerouted to focus on necessities. And even for the lucky ones who are still working, if it's from home, the need for new apparel is greatly reduced.

Although many apparel retailers are trying to compensate for the situation through e-commerce, this segment likely doesn't generate enough revenue to cover debt and expenses, so companies are resorting to maintaining their cash on hand by severely cutting operations until the situation returns to some level of normalcy. Even Target (TGT -2.24%), which offers a wide assortment of goods and reported outsized overall revenue growth for March, said that most of its revenue was coming from low-margin goods and consumer staples and that its apparel sales were lower than usual.

Customer shopping at Gap.

Image source: Gap.

How COVID-19 affects Gap

Gap is particularly vulnerable at this time since it was already suffering significant retail headwinds before the coronavirus blew through the sector. Amid several quarters of decreasing sales growth, long-standing CEO Art Peck left the company in October. This presented an opportunity for another attempt at reviving the company. Promoting internally, Old Navy boss Sonia Syngal stepped into the overall CEO role after a careful search, but any efforts she had initiated or had planned have been derailed by the pandemic. 

The fourth quarter of fiscal 2019, which ended in February, saw the company stabilizing after decreasing revenue for the previous four quarters. While discussing the earnings report, Syngal admitted that it still wasn't clear how the company should proceed with the Gap brand, but that it was intensely working through the dilemma to regain brand strength. 

What are Gap's (and its stock's) chances for recovery?

It's not quite fair to say Gap is done as a retailer. Its e-commerce business is quite strong with $4 billion in net sales (accounting for a quarter of total revenue in 2019), so it's poised for the current situation of buying at home.

However, its balance sheet looks pretty weak right now, and its cash position is seriously imperiled. If stores don't open soon, it may not be able to make it through the downturn. The company began the 2020 first quarter with $1.7 billion in cash, cash equivalents, and short-term investments, but it also had over $3 billion in current liabilities. While outgoing CFO Teri List-Stoll said the company was "comfortable with our desired cash cushion of about $1 billion to $1.2 billion," without much-needed in-store revenue, it may not be as comfortable.

Gap is doing what all of the troubled retailers are doing -- trying to get more cash on hand to make it through. It canceled orders for the fall since it simply cannot absorb the cost, and for in-store summer merchandise since it had nowhere to sell it. 

Gap has also been furloughing employees as of April 1 as stores continue to stay closed. On March 26, Syngal said, "After taking the extraordinary measures of temporarily closing all of our company-owned stores in North America and Europe two weeks ago, we are now in a position where we must take deeper actions." Gap has drawn down its full credit line of $500 million, as well as cut $300 million in capital expenditures to stay solvent through this crisis. 

As the situation gets worse, Gap announced Thursday that it would stop paying rent for its stores that are not in operation, which comes to around $115 million a month.

While there's still ample room for Gap to reopen its various store brands, recoup its losses, and get back to full strength, it may take a very long time for the share price to increase even under the most favorable of circumstances. Right now, as much of a steal as Gap shares look because they are trading at a 25-year low, I wouldn't recommend buying this stock.

Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

The Gap, Inc. Stock Quote
The Gap, Inc.
GPS
$8.21 (-2.15%) $0.18
Target Corporation Stock Quote
Target Corporation
TGT
$148.39 (-2.24%) $-3.40

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