Why Is Gap Investing South of the Border?

On Monday, Gap (GPS 1.08%) announced details of its global expansion plans. The company is going to enter Hungary and Paraguay and will expand its presence in Mexico this year. The new locations will increase Gap's exposure to Latin America, giving it a foothold in eight countries. This new push comes right after a winter opening in Uruguay, which acted as a testing ground for further South American locations.

The deep south
The Uruguay store was opened in Montevideo in November last year, and the Paraguay store should be coming later this year. Both locations are relying on a partnership with Neutral for their on-the-ground operations. In addition to Paraguay and Uruguay, Gap has locations in Chile, Panama, Colombia, Peru, and Brazil. The expansion into South America solves a whole boatload of problems for Gap.

First off, it gives Gap more exposure to reverse seasonality. That means that while Gap USA is selling sweaters, Gap Paraguay can be selling swimsuits. Not only does it allow the company to work a wider range of new products in through the whole year, it also gives it a pressure-release valve for extended periods of unseasonable weather. This year, for instance, the cool spring has caused many retailers to see less demand for seasonal products -- locations in South America can help pick up that slack.

In addition to giving Gap a place to sell its overstock, South America also gives Gap a way to add to its global brand image. The CEO of Neutral, Enrique Urioste, said that Gap holds a more aspirational place in the minds of South American shoppers. That premium is going to come with a price, and Urioste said that Gap clothing will have a meaningful markup from its American equivalents.

Because of that aspirational quality, Gap clothing has been counterfeited or sold through illegal channels more than it would be in the U.S. By moving into the countries that have these issues, Gap has an easier way to manage the branding and legality of its products.

Mexican expansion
Gap is also pushing its Banana Republic brand into Mexico, with its first freestanding store opening late in 2013. Gap opened its first Gap stand-alone in Mexico City in September last year. The Mexican expansion should also help the company balance its seasonal products while offering a popular brand to Mexican consumers.

Mexico also presents an easier point of international entry for the company. Uruguay had to act as a sort of testing ground for international sentiment, and gave Gap a chance to learn the market before it opened a location in Paraguay. Mexican consumers are more closely tied to American tastes, and other companies have already made the push, including H&M, which is the second-largest apparel retailer in the world.

The Latin American push is good news for Gap investors, who should see a profit from the new exposure and strong margins. The plan also provides a good counterbalance to the focus that so many retailers have placed on Asia and China, in particular. I'll be watching for more expansion as the brand catches on, especially in Mexico, where Gap already has some presence.