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Morningstar | Namesake Gap Brand Weighs on Company Performance, as Merchandise Margin Pressure Persists

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 20% in 2013 to 14% in 2017. The challenge the company now faces is to minimize fashion misses and inventory mismatches through a responsive supply chain, become more technologically sophisticated for younger consumers, and maintain a differentiated and relevant brand identity in the face of growing fast-fashion competition.The company has been rightsizing its store base while expanding its online presence, shedding about 4% of its square footage since 2014 and increasing e-commerce to north of 16% of sales. Since 2005, Gap has taken out 650 specialty stores and reduced square footage by 5 million square feet. In 2017, management announced its intention to close 200 Gap and Banana Republic specialty stores over the next three years and open 270 Old Navy, Athleta, and value-oriented stores. We expect further fleet reductions at Gap, as the firm is reassessing the underperforming half of stores going into 2019. 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 1.3% on average annually over the past three years (versus 3.1% 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 three years. We still believe that Gap's plan to pursue a pull-based supply chain would address the weakness, but the implementation of such an initiative across the fleet remains at bay.