Why Gap Will Never Be Great Again

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Gap StoreGap (GPS) investors should be pretty stoked right now.

Shares of the company behind Old Navy, Banana Republic, and its namesake apparel chain have been on fire this year. Gap's stock has climbed higher in five of the past six months, notching an impressive 47.5% gain through the first half of 2012.

It's easy to fall into the trap -- a Gap trap, if you will -- of thinking that the former Wall Street darling is back. Gap was a big retail winner through the 1980s and 1990s, but things haven't been as encouraging on this side of the millennium.

A Generation Gap

The chain that seemed it could do no wrong as it outfitted trendy shoppers with denim and khakis throughout the '90s has grown stale in recent years.

The emergence of Target's (TGT) cheap-chic allure for basics and discounters Kohl's (KSS) and TJX (TJX) loading up on more stylized apparel at compelling values have slammed Gap over the past decade. The past few months of gains must feel good to investors, but long-term shareholders know better. The stock is still trading lower than it was a dozen years ago.

Then again, today's investors should neither bask in the '90s nor lament the past decade. We're living in the here and now, and surely Gap's registers must be going crazy if the stock's been on fire this year.

Unfortunately, that's just not the case.


Leaving So June?

Gap announced its sales results for the month of June this morning. Comparable-store sales clocked in flat. In other words, the average store sold just as much last month as it did in June 2011. If we compare last month to June 2010, comps have inched a mere 1% higher over two years.

Think about that. The economy's had a chance to recover, but Gap couldn't even keep up with inflation!

Now, there's a bullish counter to that slam. The culprit this past month is a stifling 14% plunge in international comps. Gap's three marquee brands are at least moving in the right direction closer to home.

Let's look at the comps for individual brands for June in North America:
  • Gap: 4%
  • Banana Republic: 5%
  • Old Navy: 1%
That doesn't seem too shabby -- even if North American comps for the Gap brand were actually negative in June of the prior year -- but it doesn't justify the big run-up that the stock has experienced this year.

It's All About Value

Gap may not seem outrageously priced at 14 times this fiscal year's earnings forecast and a mere 13 times next year's profit target. Investors are also enjoying a reasonable 1.8% dividend yield.

However, where's the growth to justify that kind of multiple? Analysts see revenue growth slowing to a mere 2.7% next year, and that's largely on the wishful assumption that international sales will stabilize.

Let's put that kind of multiple into its proper perspective. If you think that Gap at 13 times next year's earnings is a bargain, what do you make of Apple (AAPL) at only 11 times next fiscal year's bottom-line target? Apple's actually growing, with analysts seeing top-line growth of 49% this year and 21% come fiscal 2013.

In other words, Gap isn't cheap -- and that's before one begins to wonder about where it goes from here.

After all, Gap may have stood out during the designer denim craze of the '80s and the khakis revolution of the '90s, but now everybody's pretty much selling the same stuff. The reason Gap has meandered through this lost decade is that differentiation is toast with its marquee brand, and discounters are all over the Old Navy value-pricing approach.

Retail is fickle. Shoppers move on. It's time for Gap investors to do the same.



Longtime Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple and creating a bull call spread position in Apple.


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