Morningstar | Inventory and Merchandise Concerns Likely to Weigh on Near Term, Crimping Profits at Gap
Gap is an iconic American brand, selling basics at affordable prices. The company scored a second hit with Old Navy, which has a slightly more family- and value-oriented bent. Together, the two brands contribute almost 80% of company revenue. However, consumer preference has shifted to value over brand in general apparel retail, and competition has flooded the space, namely through fast-fashion retailers H&M, Zara, and Uniqlo. Gap's adjusted return on invested capital has declined from more than 20% in 2013 to 16% in 2018. The company announced its intention to spin off its Old Navy business in 2020 (with the remaining brands staying with Gap) in order to help the struggling Gap minimize fashion misses and inventory mismatches, while Old Navy continues to capitalize on a product mix that resonates with consumers and offers a substitute to its fast-fashion competition.The company has been rightsizing its store base while expanding its online presence and expects to shed more than 200 primarily domestic Gap locations (about 30% of its North American locations) over the next two years as it tries to right the ship, which is set to impact sales by around $625 million. Since 2008, Gap has taken out more than 400 domestic specialty stores and reduced square footage materially. In prior store sizings, management focused on the closure of namesake Gap and Banana Republic locations while expanding the Old Navy, Athleta, and value-oriented store footprint. Although we believe there is sufficient room for more Athleta stores, we are concerned that Old Navy could become overstored.Although some recent weakness can be attributed to cyclical weakness in apparel, with clothing and accessory store sales growth of only 2% on average annually over the past five years (versus 4% total average retail sales growth), fast-fashion competitors appear to be taking market share, with consolidated comparable sales declining 1% on average over the past five years. Recent merchandising mishaps, complicated by difficult weather, sets Gap on the path to cede further market share in 2019, as near-term clearance could stifle top-line opportunity.The Gap is an apparel retail company. The company provides apparel, accessories, and personal care products for men, women, and children under the Old Navy, Gap, Banana Republic, Athleta, Intermix, and Hill City brands. The company has stores in the U.S., Canada, the U.K., France, Ireland, Japan, Italy, China, Hong Kong, Taiwan, and Mexico, and has franchise agreements with unaffiliated franchisees to operate Old Navy, Gap, and Banana Republic stores throughout Asia, Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate stores that sell apparel and related products under the company's brand names.
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