Kids today seem to prefer hotter youth retailers such as Abercrombie & Fitch
This fashion's in a funk
For quite some time now, I've thought Gap's long-standing struggles have damaged its brands. The Gap faithful always seem to point to its cash-laden balance sheet and its strong brands in their investing theses. But I'd argue that Gap can't scare up growth, and that when a retailer has been utilizing deep discounting to move merchandise for years, its brand starts getting cheapened in customers' minds.
Last quarter, in addition to announcing yet another downer quarter, Gap said it's dipping into its cash reserves, reducing its cash balance target to $1.5 billion from $2 billion. It will use the funds to invest in its business, increase its dividend, and repurchase shares. And while that's a good consolation prize for investors -- without that hefty stash of cash, the stock would have cratered long ago -- there's something disconcerting about depleting cash reserves while growth is stagnant.
This isn't about the latest quarter -- it's about quarter after quarter, year after year, of lackluster comps, sales, and earnings. Meanwhile, Gap's return on assets, return on equity, and return on capital have all been falling since 2004. Its great balance sheet is outweighed by many other concerns, in my opinion.
The idea that former Disney
Regardless, a turnaround will take some real genius -- disciplined financial performance and getting Gap's fashion back on track may be a tall order.
Foolish bottom line
Surprisingly, Gap shares have increased 12% this year. Its P/E ratio of 19 far outpaces its growth, too; in the last 12 months, Gap's sales have fallen 1.7%, and its earnings per share are down 16.8%. Comparing that P/E to rivals' stats also makes Gap look increasingly pricey; Abercrombie's P/E is 17, and American Eagle Outfitters' is just 14.
I know investors can do well by investing in turnaround plays -- but that implies the stocks are actually cheap. Gap's gotten way too pricey this year without ever having delivered the goods, and I see no signs that a turnaround is really under way at all. I can only foresee a rude awakening in 2007.
Is Gap going to be the worst stock in 2007? Let us know what you think by rating Gap in our community intelligence database, CAPS. If you think it's going to stink it up, rate it underperform in CAPS; if you think it's going to pull off its turnaround, give it an outperform rating. Click here to make your opinion known, and we'll declare the worst stock of 2007 -- based on your thoughts -- early next week.
Want to go back to the beginning of our Worst Stock for 2007 tournament? Right this way.