We maintain a long-term Neutral recommendation on Gap Inc. (GPS). Gap is one of the leading players in the highly fragmented specialty retail sector offering a diverse range of clothing, accessories and personal care products for men, women, children and babies. Its flagship brands include Gap, Banana Republic, Old Navy, Piperlime and Athleta. Gap’s globally recognized brands complement one another, enabling it to leverage its position in the sector.
Gap remains keen on driving its international operations and has thus decided to consolidate its foreign business under one division from London. Gap’s expansion overseas has been prompted by lackluster sales in its domestic North American market. In order to counter domestic market saturation, Gap is aiming to generate 30% of total sales from its overseas operations and online business by 2013. To achieve this end, Gap has opened its stores in China, Italy and Australia and has launched an e-commerce business in more than 90 markets, which are expected to further strengthen its top- and bottom-lines performance, moving forward.
Furthermore, in order to optimize its capital structure, Gap entered into a new $500.0 million revolving credit facility maturing in 2016 with a syndicate of banks comprising Bank of America Corporation (BAC), Citigroup Inc. (C)and JPMorgan Chase & Co. (JPM). The new credit facility will replace the existing $500.0 million revolving credit facility. Moreover, the company will get a five-year term loan facility of $400.0 million. This will help in achieving the target of expanding its international presence.
On the flip side, Gap’s business is seasonal in nature and generates a high proportion of sales during the fourth quarter, which is characterized by the crucial holiday season. Furthermore, the company ramps up its merchandise levels in anticipation of the season, exposing the company to significant risks if the season fails to deliver expected operating performance.
Additionally, Gap operates in a highly fragmented market and competes with national and local department stores and discount stores, such as American Eagle Outfitters Inc. (AEO) and The TJX Companies Inc. (TJX), which offer products at fire sale prices. In order to counter aggressive pricing from peers and retain market share, the company may be compelled to slash prices of merchandise at the cost of margins.
The company’s international exposure subjects it to currency fluctuation. The weakening of foreign currencies against the U.S. dollar may require the company to either raise prices or contract profit margins in locations outside the U.S. An increase in product price may have a direct impact on consumer demand.
Gap currently has a Zacks #4 Rank, implying a short-term ‘ Sell’ rating.
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