Can The Gap Turn Things Around?
The problem with most turnaround plays is that you’re often dealing with a pernicious combination of bad management, hemorrhaging of red ink (or at best declining earnings), high debt loads, weak balance sheets, stronger competitors, a weak product mix, etc. Most companies collapse under the weight of the “Pernicious Combination” and the turnaround never happens. Fortunately, not all companies engaged in a turnaround suffer from these maladies; some are profitable and financially strong, and are just losing market share to competitors. One such company is the Gap (GPS).
The Gap has been struggling as of late, with its earnings growth on the decline for several quarters now, a decline in brand equity amongst younger buyers and the recent failure of its “Forth and Towne” Brand, an effort to reach women in the 35-45 demographic. However, the company has a solid balance sheet:
• ROA: 8.14%
• ROE: 13.46%
• LTM EBITDA $1.68B
• Total Cash: $2.74B
• Debt/Equity: 0.096
The bad data point is the 26.40% YOY earnings growth decline [LTM]. Still, the company is profitable, has a good amount of cash on hand and very little debt.
For a company in need of engineering a major turnaround, things could be a lot worse. When speculating on turnaround plays it’s always good to have some actual profitable companies in your “Turnaround Portfolio” to go along with the companies flirting with bankruptcy. However, before we make the decision to invest in the Gap as a wager on its future, let’s understand what went wrong.
The common story is that Gap has simply failed to position itself as a “Hip, Edgy Retailer” in the same vein of Abercrombie (ANF), American Eagle (AEO) and other successful clothing retailers like J-Crew (JCG). However, the bigger question is: “Why?” I could probably write volumes on this, but I think the answer comes down to a couple of rather simple factors:
1) The parents of the consumers Gap desires often shop at their Gap and Banana Republic stores. I’m barely 30 and grew up shopping at the Gap and Banana Republic, with Abercrombie not really coming onto the scene until I was in college. The thing is, when I was a young teen shopping at the Gap, college students and those fresh out of college were shopping there as well, back when Gap was a rapid growth story. Now those same consumers are in their 40s and are still shopping there while their kids excuse themselves to go to the part of the mall where Abercrombie is. You can’t be an edgy clothing retailer when you’re selling large volumes of goods to your desired market’s parents.
2) People my age primarily buy their work clothes at the Gap & Banana Republic and their casual clothes somewhere else. That fact is probably what has enabled J-Crew to thrive all this time, despite not necessarily changing or having the hipster credentials of ANF, as it has managed to retain its status of the provider of high-quality, but casual clothing. From a brand perspective, this positions Gap as the provider of “Uniform Clothing”, your standard khakis, suits, skirts, dress shirts, slacks and sweaters that you wear to the office. From a young person’s perspective, it makes Gap and Banana Republic a place they’re not interested in shopping for their “fun fashions”, unless they need to wear professional clothing to work. It’s worth nothing that neither Abercrombie nor American Eagle carries professional clothing.
3) Old Navy has been positioned as a discount retailer. Each commercial, despite its attempts to be kitschy and hip, has Old Navy competing on price. Meanwhile other retailers are offering somewhat similar, but more upscale versions of a similar type of fashion. As a result, young consumers are more likely to aspire to shop at Abercrombie, American Eagle, Guess (GES) and the like. Building a strong clothing brand means that shopping at your store needs to be an aspiration, as opposed to being a form of utility due to low prices.
4) Lack of a brand identity: Whether you’re talking about the company as a whole or its individual brands, there isn’t a clearly defined brand identity, that’s backed up by their advertising, the look and feel of the stores and its products. A few years ago, the Gap went from using Sarah Jessica Parker as a pitch woman to Joss Stone, which begs the question: Who are you marketing to this week? Women in their late 30s or teenagers? The company needs to establish an articulate brand identity for each brand and back it up with the product mix.
Based on the product mix, Gap seems to vary from being trying to be hip to selling casual professional wear. Banana is the more upscale brand, that seems to vary between being a notch or two above Macy’s to maybe wanting to compete with Kenneth Cole. In short, brand needs to make choice identity wise and then create a feeling around each one of its brands.
So what would be the signs of a Gap turnaround?
1) Reestablishing the brand, with the first key being the company behaving as if it’s in touch with the customers it wishes to court.
2) A new attempt to court the female shopper in the 35-45 age range, only with them sticking with it this time around and getting the job done.
3) A stronger and more stable product mix that appears in tune with the Gap’s efforts to rebuild its brand.
4) Breaking of their pattern of selling “uniform” clothing and offering a wider and more diverse product mix.
So what’s an investor to do? Currently trading at roughly 21X earnings, vs. 15 and 15 1/2 for Abercrombie and American Eagle respectively, the company‘s stock looks a little pricey, particularly when you consider that both of its competitors are actually growing profits (albeit not at the same rate as in years past). However, the current price is in line with its 200 day moving average, meaning that over the last couple of quarters, weak earnings reports haven’t done much to depress the stock, so there shouldn’t be much downside at current levels.
My suggestion is to watch the company and watch for signs of them addressing their key issues; view the company as a potential buy at its current levels and a strong buy if it dips below the current price. As mentioned before, a strong balance sheet gives a company the luxury of time while it’s trying to figure it out, the question offered is: does the Gap actually understand its problems?
Disclosure: Author has no position in GPS
GPS 1-yr chart
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This article has 6 comments:
- scott146
- 69 Comments
My Website
Jul 11 12:33 PMI think that the Old Navy line should just be liquidated; long-term I don't think that the business model can survive against Target and Walmart. When your kids are shopping for discount clothes, they don't want to advertise the brand when they wear the clothes. Perhaps they could negotiate a deal to sell Old Navy branded product through Walmart's stores and eliminate the store overhead they have now.
Last time I looked, Banana Republic's prices were significantly higher for similar items that Gap's. I see BR as competing with Nordstrom. I suppose Gap's theory is that once you get to a certain income level you will shift to shopping at BR from Gap. That doesn't make any sense because it's shifting sales around within the company as a whole.
My answer to your question is that I don't think Gap management understands its problems and is basically throwing darts and hoping they hit something. I think the best course of action would be for a breakup of the company. Spin off BR as an independent company, liquidate Old Navy stores and cut a deal to market the product through an established big-box discounter, and focus on the Gap brand by reinforcing the denim and business casual product line and accept a position as a value stock rather than a growth stock.
- Markham
- 70 Comments
My Website
Jul 11 02:06 PMSecond - I think your idea about liquidating Old Navy is probably a good one, as it presents a negative halo effect for the larger brand. Selling it to Wal-Mart would probably destroy it though, I'd sell it to Target or JC Pennys.
Third - I think BR just needs to push solidly upscale instead of wavering between upscale and being a pricier version of the Gap. My suspicion is that their higher end items sell better anyway, so just making a strong move in that direction is probably the best way to go.
Fourth - I think the diversified product mix is a good idea. Young people shop at J-Crew and Nordstroms and so do their parents, as there seems to be enough for everyone.
Fifth - The move towards managing themselves as a mature company is a good one, but I think they need to put a stop to their rapidly eroding earnings growth first.
- rhodope
- 22 Comments
Jul 12 02:35 PM- Markham
- 70 Comments
My Website
Jul 12 03:06 PMFor me personally, I shop at their Banana Republic Brand simply due to the fact that their clothes fit me off the rack, thus saving me a few bucks on alterations (ex college athlete who actually stayed in shape) and most other places create pants for, well, 120 lbs male models/or just require a lot of alterations.
Still, going to your comment about "What's the Hook?" that's what I mean about establishing a Brand Identity, your question is a clear indicator that their brand identity is lacking.
Thank you for the feedback.
- slickvguy
- 14 Comments
Jul 17 07:16 AMYou pointed out a number of the problems, but let me also add that this company operates like a large bureacracy, akin to government. They are far too inflexible. Technologically outdated too. They are inefficient and in many cases flat out incompetent.
But getting back to the marketing, not only has the Gap lost my daughters as they became teens, but they've also lost me. I do shop a bit at BR, but find them to be very overpriced for the quality they offer, and their clothes don't fit well. I find their lines puzzling. Too much of it is basic, Gap style, an not worth the price difference. The Gap's merchandise quality and manufacturing quality control has also slipped over the past few years. Go try on 4 pairs of the exact same size (waist and length) jeans, and it's amazing how differently one pair to the next will fit you! I (and many others I speak to) also find that there is a strong GAY-ish aspect to their male clothes (aside from the basics).
Bottom line: who does the Gap satisfy? Answer: very few.
And that's the problem, because if they were smart enough to REALLY change (especially their name - "The Gap" is too entrenched in people's minds as "boring"), they'd have to choose ONE part or another of the market, and their sales would be smaller (though possibly more profitable?). Trying to be all things to all people hasnt' worked, and trying to be "hip" hasn't worked. No matter what merchandise they put in a Gap store, my kids won't buy it. For them, it's simply too UNCOOL to shop at the Gap. American Eagle et al is where they shop. That's yet another reason I recommend the name change.
But they won't let go of the past, and thus they are doomed. We've seen this countless times. They are trying to make small changes here and there, but they are missing the big picture. They refuse to accep that times have changed, and so have their customers. They need to *CHOOSE* what it is they stand for (image) and who it is they want as their market. You cannot be all things to all people.
They made a huge mistake with Old Navy and Banana because they see their 3 brands as PRICE LEVELS. Instead, they should have positioned them as 3 different IMAGES to market to 3 different sectors. Follow? The current situation is ridiculous. You can go into Old Navy, Gap, and BR and see the exact same items - only at different quality levels (and slightly different colors). That's nuts! Old Navy should have been the COOL store - not cheaper - COOLER! As someone pointed out, you can't compete on price with the competition - and why would you want to? The Gap should be left for the basics. And BR for the yuppy/professional. Of the 3 units, BR is the closest to being positioned properly.
Sorry for the long post, but it frustrates me to see a company with so much potential just pizzing it down the drain. They need RADICAL changes, and the odds are that it won't happen.
p.s. The one area I give The Gap full marks for, is the shopping experience. Once you enter their stores, and try to buy, their staff is just about the only staff I encounter who are TRAINED to assist the customer in such a professional manner. Especially in the changing rooms. They really make the effort. The stores are well-managed. Too bad the company (top-down) isn't.
- slickvguy
- 14 Comments
Jul 17 07:36 AMAs far as GPS as an investment goes, one of the cornerstones of value investing is that management should be superior. From Buffet to Whitman to Cundill - they all agree on that point. Why in the world would you invest your hard-earned money with a LOUSY management? They frankly don't deserve it. And the compensation is insane at the upper levels of this poorly performing company, while at the same time they are cutting back staff and reducing raises for "the troops". That's the type of behavior that should not be rewarded by investors.
I trade this stock once in a while, up and down, but I would not consider it a wise turnaround play. Especially not at these prices.
For over 5 years I've been hearing the same thing from GPS, as they frantically try to reinvent themselves. But they just don't get it. Living in the past. Reminds me of the NYT.
There are cases of old companies that became stale, yet were able to successfully reinvent themselves. But most don't. The main problem here is not financial - it's psychological. A radical shift is needed. It's ironic - because their customers have shifted, yet those in control of the Gap have not. It's putting the very basics of marketing on their head! Bizarre.