Gap’s Story Looks Too Good to Be True

By guest author Jinjoo Lee from Wall Street Journal

Great brands tell great stories. Gap, GPS Inc., which says its flagship brand “stands for American optimism,” certainly told a convincing one during its investor day on Thursday, sending its shares up more than 13 %. There are a few holes in the plot, though.

Caption courtesy by Wall Street Journal

Old Navy and Athleta, its youngest and most profitable brands, are the stars of this story—no surprise there. But there was some specific new guidance: The apparel company figures those two brands will come to account for 70 % of its net sales by 2023, up from 55 % last year. The store fleet will also adjust accordingly, with the two brands accounting for 52 % of stores in three years compared with the current 42 %.

Meanwhile, the company gave hard numbers around store reductions for Gap and Banana Republic, but no specific guidance on their revenue. The North American store fleet for those brands will be 30 % smaller by the end of fiscal 2023, alongside a smaller product assortment for the Gap brand. The company also confirmed that it is conducting a strategic review of its Europe business that could lead to franchising or closure of company-operated stores. The goal is to reduce its footprint in high rent, low productivity places—such as malls—to grow earnings before interest and taxes as a share of revenue.

That’s where things don’t quite add up, though. Gap already has some experience whittling down its store footprint: The Gap brand shrunk its store base by 17 % between 2015 and 2019, but both EBIT margins and EBIT dollars declined for the company over that period, according to research from Citi. That was true of many other apparel companies that closed unproductive doors, leading Citi to conclude that “big store closing activity more often proved to be a sign of a problem rather than a fix.”

Good thing then that Gap has those other brands. But those targets too look quite optimistic. Old Navy is eyeing annual revenue of USD 10 billion by 2023 by growing sales 6 % a year on average while slowing store openings. That seems a slight stretch from the previous three years’ average annual growth rate of 5.4 %, especially because a larger market share can lead to slowing growth. Athleta is more of a wild card—it plans to double its revenue to USD 2 billion over the next three years, which seems entirely doable for a growing brand, but it faces an increasingly saturated market as others pivot to the fast-growing category of athletic apparel.

Perhaps the really good news from Gap’s investor day was the company’s assurance that it will keep all four brands together, a pivot from last year’s talk of spinning off Old Navy. Fashion trends can be fickle; value and comfort-driven apparel drive sales at Old Navy and Athleta today, but when the pandemic is over that trend could easily reverse and bring Banana Republic’s more work-appropriate assortment back in favor. There are other measurable perks that come with scale, too, such as having preferred status with logistics services, as Chief Executive Officer Sonia Syngal noted during Thursday’s (Oct.22) presentation.

Following Thursday’s rally, Gap shares now trade above their pre-pandemic levels. As much as Gap’s targets look enticing, investors may want to see how the story actually plays out.