Robert Woronoff
submits:
After a brief fling in the 2004/2005 time frame, I have recently
begun a position in Gap Inc. (
GPS
). (Shouldn't Garmin (
GRMN
) have that ticker?)
What I like about Gap is over the last 5 years, the company has
made a substantial effort to reduce their common shares outstanding
with excess capital generated from their operations. As a mature,
fully saturated retailer, the company has given up the ghost of
growing unprofitably in the US. Management has worked to reduce
both the square footage and number of stores in the US. The Gap,
Inc. has healthy free cash flow, limited Cap Ex needs, and been
aggressive about allocating capital to buying their own stock and
growing the dividend.
The company is investing in growing sales internationally with
all three major brands, Gap, Old Navy, and Banana Republic, by
establishing flagship stores in Canada, UK, China, France and Italy
as well as, further investment in their website and international
shipping capabilities. Management says they do not have stores in
markets where ¾'s of global apparel sales take place and that is
their growth opportunity. In 2010, Gap, Inc. invested in the
ability to ship on-line orders to over 90 different countries. They
are also allowing franchise owners to create more stores in a
number of mid-tier international franchise markets like Korea and
several Middle Eastern and Eastern European countries.
The company is opening GAP Outlet Stores in the Canada, UK and
Japan. Management is reducing the square footage in the US by
combining Gap, Baby Gap, Gap Kids, and Gap Body stores into one
store, shrinking the size of Old Navy stores, and trying to drive
more sales through their website. They are also investing in both
the Piperlime on-line sales platform and constructing stores in San
Francisco, New York and LA to support their newer Athleta brand,
which the company purchased it in 2008. Althleta has been primarily
a women's athletic clothing catalog and on-line site without a
retail presence.
The data point that caught my attention was the reduction in the
number of shares outstanding for the company. From approximately
897 million shares in 2003, Gap Inc, has repurchased over 31% of
their stock so that at the end of 2010, there were approximately
612 million shares outstanding. The company announced a $2 billion
dollar buyback and increased the dividend to $.45/share/year with
their 4 th quarter
earnings release
(in February 2011), so that the yield on GPS is a little under
2%.
Another development is the initiation of a major position (5% of
shares outstanding) by a respected value hedge fund manager.
Normally, I do not get too excited about hedge fund presence due to
the fleeting nature of some of their investments. However, this
particular manager typically takes a long-term time perspective on
his fund's retail investments. Donald Fisher, the company's founder
passed away in 2009. His wife and children and their foundations
own approximately 35% of the shares, although I did not delve into
the details of those holdings. Two family members serve on the
Board of Directors of the company.
The stock price of GPS has been in a 10 year trading range, so
it is easy to see why investors fail to get excited about this
equity. From August 2001 to present the stock price of GPS has
primarily vacillated between $15 and $23 per share - briefly
breaking above and below that range but for no extended period. In
reviewing the company's financial data in Value Line, EPS of
$1.26/share in 1999 were not exceeded until 2008, clocking in that
year at $1.34/share. Sales peaked in 2004 with receipts of $16.267
billion, earnings were $1.21/share. In 2010 sales tallied $14.575
billion, but earnings per share were $1.82. The company has no long
term debt, although they do have lease obligations of over $1
billion/year.
The market capitalization of the equity is approximately $13
billion. Operating margins have shown similar improvement to
earnings; whether they can stay high remains to be seen. One
investment question is has the company extracted all of the excess
costs from their operations so that they cannot continue to grow
gross margin and EPS with limited or no sales growth? The American
retail apparel marketplace is over-stored and very competitive. Can
Gap generate a lot of cash over the coming years by growing
organically in international markets and reducing their square
footage in the US?
In short, I believe the company's operating strategy makes a
great deal of sense and the stock trades at a reasonable P/E
multiple and Enterprise Value/EBITDA ratio. The price of the stock
is consistent with the company's recent performance, however, I am
betting the continued focus on using excess capital to repurchase
shares will grow EPS at a far faster rate than the company's
revenue line. Organic sales growth would be an additional bonus.
The company's EPS and gross margins continued to grow through the
Great Recession, which I believe shows the strength of Gap, Inc.'s
brands. The company has generated unlevered returns on equity and
assets in the low 20+% range for the last four years, which were
not particularly friendly years to apparel retailers. On top of all
this, are the company's share buybacks. Additionally, they have
$1.6 million in cash, although they probably should keep between
$1.2 million and $1.4 million on hand.
What could go wrong? The three major risk factors that I see are
inflation pressure on COGS without the ability to pass those
increased costs along to consumers; execution risk/market
acceptance in the new expansion international markets; and
maintaining fashion relevance with the company's core North
American consumers (amongst all three major brands). Commodity
inflation is a factor that could depress earnings in 2011 and
beyond. The company is forecasting lower operating margin in 2011.
Another major risk that I forsee is the market acceptance in the
new markets in Europe, China, et al of the company's brands.
Are GPS brands differentiated enough from the current offerings
in those markets? Best Buy's (
BBY
) recent experience in China shows that every international market
is different from the US and taking a successful concept in the US
and copying and pasting it into other markets does not always turn
out successfully. The third risk factor is not meeting the fashion
desires of the North American consumer of Gap's brands in an
hyper-competitive, over-stored U.S. marketplace.
Management has shown their capital allocation discipline by
using excess cash generated by the company to buyback shares and
increase dividends rather than over investing in stores in the US.
They are continuing to work on the fashion offerings of their three
major brands and spreading out their creative designers amongst
their global markets by opening design centers is Asia and Europe.
With the Fisher family's presence by way of their 35% stake in the
common stock, this company can be run for the long-term rather than
quarterly numbers, with the added bonus of not needing much
leverage. I do not expect the price performance of this equity to
be dramatic nor quick, but I believe over the next 3 to 5 years,
with a little bit of sales growth, it could be substantial.
Disclosure:
I am long
GPS
.
See also
Stewart Enterprises' CEO Discusses Q1 2011 Results
- Earnings Call Transcript
on seekingalpha.com