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Gap: Great Potential, But Where is it Going?

by: Todd Sullivan June 14, 2007 | about stocks: GPS / SHLD    
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In early February I posted about The Gap (GPS) and as it has been almost six months. Time for another update like I did yesterday for Caterpillar (CAT). It is important to look back at you decisions, as it is a great learning experience.

Best to first read the February Gap post here, then continue with this post, as it will be referenced.

From January:

Numbers: We need to break everything down to per share amounts. Why? You pay your price for the company on a per share basis, we need to find out what you are getting for that money by the same metric. Currently Gap has 900 million shares outstanding and roughly $2.5 billion in cash (this amount has typically risen after the holiday season but we will use "what is" rather than "what could be"). That gives us $2.77 per share in cash. It's property is valued at $7.2 billion or $8 a share (this is carried at an undervalued level, I will use it though so as not to be accused of fudging numbers to make a point, again, "what is"). Profits will be about 85 cents a share and the dividend is 32 cents a share. At this profit level, investors are paying 23 times 2007 earning (16 times the $1.25 they earned in 2006). The total value of the cash, property, earnings and dividends is $11.94. Sales look to be about $16 billion this year or about $17.80 a share.

Where are we now?

As of May 5th, Gap now has $2.7 billion in the bank, EPS looks to be on track to finish the year around the 85 cents a share and the dividend is the same. Shares outstanding have increase two million, but that is a function of the timing of repurchases vs. employee options and the overall number should continue to decrease. Debt is unchanged and still essentially irrelevant. Q1 2008 revenue (quarter just completed) rose over Q1 2007. In March they announced the long overdue closing of the Town & Forth chain and are expanding the best performing unit, Banana Republic, a great move. Growth of the over-saturated Gap line is being reigned in and the popular Old Navy brand in on track which is better but not really good enough. More decisive action probably wait until a new CEO is installed.

So, what to do? The stock price is essentially unchanged since the original post and until our single determining factor is answered, we should remain on the sidelines.

From February:

I am not buying shares of Gap now, nor do I currently own any. I want to hear what the new CEO says first. If they just continue the same path and try to jazz it up through more advertising, I do not see a resurrection of the Gap brand. In that scenario, I believe they are in for another five years of mediocrity. But, any hint of them closing unprofitable locations, and I am jumping in as I think we'll have a Value Play.

What do I really want? Ideally, Eddie Lampert at Sears Holdings (SHLD) buys them. He is raising $3-$5 billion for more investment and with the cash he now has at Sears (almost $4 billion) he could easily do the deal. Now that Julian Day is in the process of fixing RadioShack (RSH) after he laid the groundwork at Sears and Kmart, would he like a return to a bigger stage with his buddy Lampert at the Gap to cement his fame as a retail turnaround whiz? The thought of this makes me want to run out and buy Gap shares, but that would be foolish. Like I said above, if the new CEO is just more of the same, shareholders will just get more of the same, which is not much.

I think Gap is in wonderful shape and has great potential, I just need to know the direction they are going in.

GPS 1-yr chart:

GPS

Todd Sullivan

Todd Sullivan

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This article has 2 comments:

  •  
    Jun 14 10:48 AM
    If Lampert took control, perhaps a sensible strategy would be to move the Gap stores concept into the Sears and Kmart buildings as the mall leases expire; in fact, why not move the Old Navy concept to the Sears and Kmart buildings as well.
    Reply
  •  
    Jun 18 06:14 PM
    I agree with your notion about SHLD acquiring Gap. I’m surprised it hasn’t happened, yet. My guess is that they would bring the Gap brand into Kmart/Sears and keep Banana Republic and Old Navy as stand alone operations. And, by the way, Gap needs Kmart as much as Kmart needs Gap. The real estate advantage and purchasing power of Sears Holdings and combining that with a revitalized Gap brand, provides the potential for a vital retail operation based on positive brand experience and profitability. The combination could make Kmart the category disrupter into the next decade just as Wal-Mart and Target have been in the past.
    Any retail operation can have moderate success with a keen understanding of merchandising. However, if that sense is combined with an overall vision of brand building, the retailer can avoid forever slashing prices to meet sales goals. Lampert and President, Alywin Lewis, are one of a handful of retail leaders who understand that building and leveraging a strong brand results in increased profitability and corporate value. David Lemley, Lemley Design
    Reply
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