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Is Gap Stock a Buy?

By Rich Duprey - May 20, 2020 at 8:40AM

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It's hard to find residual value in this retailer with the odds so stacked against it.

Gap (GPS 0.48%) was already a troubled retailer before the COVID-19 pandemic struck, and after nearly two months of store closures, it is even more so.

While J.C. Penney, J. Crew, and Neiman-Marcus were largely forced into bankruptcy by the arbitrary nature of which stores were deemed essential and allowed to remain operational, the situation with Gap isn't so dire. With its stock at a 25-year low, let's see whether this makes for an opportune time to buy.

Gap employee folding clothes

Image source: Gap.

Preparing for the worst

Gap had an approximate $1 billion cash cushion and turned off the spigot on most of its expenses by furloughing its employees, suspending its dividend, canceling orders from vendors, stopping rent payments on its stores, and drawing down $500 million on its credit line.

Now, it is reopening stores where permitted and with acceptable health and safety protocols, but that doesn't mean sales will return.

First, consumers are going to be cautious before rushing back to the mall, as they've adapted fairly well to social-distancing measures and the forced migration to e-commerce. 

While several surveys found consumers are spending less and saving more than they were in the first wave of the pandemic (likely because there are 36 million people unemployed with the economy sliding into a recession), almost half of respondents to a March 18 survey from Coresight Research said they will not revert to their pre-pandemic habits after the crisis passes.

The omnichannel lifeline

There is both good and bad news in that for Gap. On the one hand, consumers weren't eager to shop at Gap, Banana Republic, or Old Navy before the pandemic -- none of the three brands recorded a single quarter of same-store sales growth in 2019. That means the retailer isn't going to see a flood of customers waiting to buy its merchandise now that it's reopening stores.

On the other hand, Gap does have a fairly strong e-commerce platform generating over $4 billion in annual sales across the company, about a quarter of the top line. The retailer's new CEO, Sonia Syngal, also grew Old Navy's e-commerce business into the fourth largest apparel site in the U.S.

Yet Amazon has become the largest online apparel retailer, surpassing Macy's, whose future is now also in grave doubt, meaning Gap will continue to have difficulty competing, just as it does in the physical retail market.

Going off on a tangent

That is leading Gap to try a new tactic, which is to capitalize on its residual name recognition and value by becoming a lifestyle brand. The retailer recently announced it would branch out into home furnishings and baby care products through its Gap, Banana Republic, and Janie and Jack chains.

This strategy to branch out into a department store-style retailer is misguided, especially as department stores themselves look like they're slowly dying out. But it's also because other than Janie and Jack, the chains Gap is using to launch this initiative have fewer consumers who want its products, hardly suggestive of their desire to adopt the "lifestyle."

Gap may need to embark on a radical new course, but adding branded textiles, furniture, and home decor does not seem to be the right solution. Rather, a much smaller physical footprint and far more expansive digital offerings with apparel more in tune with consumer tastes seems a better path for it to chart.

A search for residual value

Yet with a share price that has been under so much pressure, it does look like an attractive value stock. Gap trades at about eight times trailing earnings and three times free cash flow. It goes for just a fraction of its sales and book value too.

In other circumstances, that would signal an opportunity to jump in, but with the current situation, investors should proceed with extreme caution, though I wouldn't reject it outright either. 

Gap is not about to go bankrupt. It does retain considerable brand recognition even if its value is diminished, and it may be able to leverage its digital assets further.

I wouldn't put a lot of money into this stock, but Gap could fill a niche in the smaller, more speculative portion of your portfolio. I'd argue there are better stocks for your money, but if you wanted to take a flyer on a comeback story of an iconic American retailer, Gap could be the one.

 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

The Gap, Inc. Stock Quote
The Gap, Inc.
GPS
$10.43 (0.48%) $0.05
Macy's, Inc. Stock Quote
Macy's, Inc.
M
$19.43 (-0.49%) $0.10
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$140.34 (-0.21%) $0.30
J. C. Penney Company, Inc. Stock Quote
J. C. Penney Company, Inc.
JCPN.Q

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