Clothing retailer Gap (GPS 5.49%) owes the majority of its recent growth to its market-leading apparel brand Old Navy and its high-margin, high-growth activewear brand Athleta. Unlike these two brands, Gap's namesake brand has seen sales decline since 2019.
Will the company's plans to strengthen the Gap brand succeed, or will the brand continue to weigh the company down? The answer will lie in Gap's execution of its 2023 "Power Plan" and the success of its developing partnerships, especially those with musician-designer Kanye West and mega-retailer Walmart (WMT 0.96%).
What's going right
In Gap's first-quarter 2021 earnings report, the company reported sales growth of 89% over the prior-year quarter and 9% over pre-pandemic levels in 2019. The overall picture is a positive one, but digging into brand-specific results gives a more comprehensive understanding of the company's performance.
Ninety-eight percent of Gap's revenue comes from its four major brands: Old Navy, Gap, Banana Republic, and Athleta. Old Navy and Athleta make up a combined 66% of revenue, and the company aims to increase that number to 70% by 2023 as part of its ambitious Power Plan to restructure its brand makeup and build strategic partnerships.
Old Navy and Athleta are higher-margin than Gap and Banana Republic, helping the company become profitable again ($166 million in the first quarter of 2021 versus an expected loss) after posting a near $1 billion loss in Q1 2020 when shopping malls closed their doors. Both brands are also growing fast: Old Navy and Athleta sales are up 27% and 56%, respectively, over pre-pandemic levels in Q1 2019.
Because of the gap (no pun intended) in brand performance, the company plans to close down 75 Gap brand and Banana Republic stores in North America in 2021. Gap will open almost as many Athleta and Old Navy storefronts in their place, but the company will locate these new stores more strategically than Gap's traditional indoor mall locations.
According to the company, strip mall locations, street locations, and online sales together make up about 80% of all revenue, while indoor mall sales have fallen to 17% of revenue. E-commerce is a continued focus and makes up 40% of the company's total revenue as of its Q1 2021 earnings report, with online sales growing 61% over the prior-year quarter and 82% over 2019.
What's going wrong
The company's earnings report raises the question: What will become of Gap's namesake brand in the long run, and will it continue slowing overall growth? Gap's 16% sales decrease compared to the pre-pandemic first quarter of 2019 is a stark contrast to Old Navy's and Athleta's double-digit growth over the same period.
By the end of fiscal year 2023, Gap expects to close 30% of all Gap and Banana Republic stores in North America -- about 350 locations in total. This shift is partly because of the company's increased focus on e-commerce, but for no-moat Gap to lose this much brand visibility will surely mean even bigger declines in Gap brand sales growth in future quarters. Despite sales decreases, Gap brand still accounts for 22% of overall company revenue; therefore, the development of the namesake brand is still vitally important to the overall growth picture.
The company plans to put Gap brand products back on the map in a different way after pulling them out of shopping malls. Gap has partnered with fashion icon Kanye West for a Yeezy Gap clothing collaboration, which is expected to launch this year. Another valuable, but very different, collaboration is Gap's partnership with Walmart for a home goods brand.
Can the Power Plan fill in the gaps?
Gap's Power Plan will almost definitely lead its namesake brand back to an upward sales trend in the short term, but the long-term implications for the brand are worth discussing. A brand's messaging and target market are both crucial for its long-term success, and Gap's broad shopping spree for partnerships may end up confusing consumers about its brand message.
While an apparel partnership with Kanye West positions Gap as a modern, hip clothing retailer, a home goods partnership with Walmart paints it as a big-box style discount manufacturer. The Yeezy Gap collection will likely be priced in accordance with mall price points and is expected to be worth almost $1 billion -- about one-fourth of the company's first-quarter 2021 revenue.
Alternatively, Walmart's Gap line will carry products priced between $15.88 (for a pillow) and $64.98 (for an entire comforter set), and teaser images so far reveal a traditional, simplistic brand image -- far different than Gap's ambitions for its stylish Yeezy line. Contrast this brand new, unexpected Walmart-Gap partnership with Target's limited-edition accessories line with Levi Strauss brand Levi's. Target had already been selling Levi's products for a decade, and the retailer has a brand image and price point better matched for Levi's, leading to a more logical and relatively successful brand partnership.
While both the Yeezy and Walmart partnerships can help Gap brand boost sales through brand visibility and distribution, the long-term effect could easily weaken the brand image. It is more difficult for a company to build a moat (a sustained competitive advantage in its space) if it is not hyper-focused on its product and target market. In this case, the Power Plan's strategic partnership initiative seems less like focus and more like tossing spaghetti to the wall to see what sticks.
Check back next quarter
Don't get me wrong, it is not time to give up hope on this stock. However, considering the reasonable brand-related reservations about the Power Plan, Gap stock seems overpriced at the moment.
The stock is trading at a P/E of 29, about 1.5 times its fair value estimate, according to Morningstar's analysis of the company's future value and cash flows. In the next quarter's earnings report, look out for growth in Gap brand sales and an increase in overall Gap company operating margins.
By then, there should also be helpful information on initial results from Yeezy Gap and Walmart's Gap line. Hopefully, these results will spur Gap to release more detailed guidance on the long-term brand messaging plan for its namesake brand.