Can The Gap Get Back On Track?

March 12, 2001 -- Not only is Gap promising consumers a hip spring clothing line, it's also promising Wall Street a complete makeover.

Changes are needed. After achieving stunning growth in the mid- to late-1990s, the clothing retailer's recent sales figures have been disappointing. While February sales were up 8 percent from a year ago, same-store sales — a key benchmark that looks at sales at stores open for at least a year — declined 11 percent.

That's after a 4 percent increase in February 2000, and follows a 12 percent decrease in same-store sales in January.

In Gap's favor are its powerful brand and dominance as the No. 1 apparel retailer in the United States, its proven ability to regain its footing after other fashion gaffes and a new slate of top executives. These factors lead several analysts and mutual fund managers to conclude that Gap is capable of regaining its footing.

Skeptics, on the other hand, wonder if the khakis king has overextended itself and is headed for the same fate as The Limited, which was all the fashion rage in the 1980s but has had to close a quarter of its stores over the past six years.

Whichever side they're on, experts agree that for the Gap to even come close to its stunning 138.4 percent stock run-up in 1998 and 23.2 percent rise in 1999, the company will have to deliver exciting goods, improve same-store sales and grapple with inventory overhang.

A cumulative 83 percent increase in the chain's square footage over the past three years was the primary driver behind the stock's tremendous ascent, they agree, but now that Gap has nearly saturated the country with more than 3,700 stores, it cannot continue to rely on a bigger footprint to perpetuate its average 26 percent sales growth of the past four years.

Got To Be Cool Again

The company faces much stiffer competition from both casual dresswear and upscale sportswear retailers like Abercrombie & Fitch and AnnTaylor.

For shoppers to once again "fall into the Gap," analysts say, Gap clothes have simply got to become cool once again.

A failure to produce exciting clothes and to differentiate its three brands — the Gap, Banana Republic and Old Navy — turned 2000 into an "extremely disappointing" year, acknowledged Millard "Mickey" Drexler, Gap's chief executive officer.

"The stores have been boring, unexciting and dull," Drexler said. "Even our marketing became a little tired."

Gap's stock lost 44.4 percent of its value in 2000, as net income declined 22 percent for the fiscal year and same-store sales fell 5 percent. Drexler is banking on improved merchandise and lower prices to boost Gap sales in the second half of the year.

But Donald Trott, an analyst with Jefferies & Company who has a hold rating on the retailer's stock, characterized Gap as "a troubled company."

All Signs Point To…

The Gap Rebounds

The Gap Slides

With 3,700 stores, 6% market share and aggressive expansion plans, Gap is — and should continue to be — the No. 1 U.S. apparel retail chain.

Gap clothing failed to inspire shoppers in 2000, resulting in a decline in earnings of 22% and a decrease in same-store sales of 5%.

Gap's sales have grown an average of 26% over the past four years, against an industry average of 9%.

Gap sales growth slowed to 13% in 2000, and some believe this may portend the future.

Gap has promised that its new slate of key merchandising and marketing executives will turn things around.

The positions of product designer at Banana Republic and merchandising director at Gap — Gap's two most critical positions, according to CEO Mickey Drexler — are still open.

Source: The company, Lazard Freres, Analysts.

One of Trott's and other cynics' primary concerns is that Gap's three brand lines have been tripping over one another, possibly even stealing market share from one another.

As Todd Slater, retail analyst at Lazard Freres, who also has a hold rating on GPS, puts it: "The Gap's mantra over the past year seems to have been, 'Let's be Banana Republic at a price,' and Old Navy's mantra has been, 'Let's be the Gap at a price.' The stores have been cannibalizing each other."

Another overriding concern of the skeptics is the Gap's expansion plans. The Gap increased square footage an aggressive 25 percent in 1998, 28 percent in 1999, 30 percent in 2000 and had planned to expand another 30 percent in 2001.

Gap now says it will trim that back to 17 percent to 20 percent in 2001 with an additional 550 to 630 new stores. Plans call for 15 percent expansion in both 2002 and 2003.

Slater points to one fundamental that could portend continued difficulties in coming months. The Gap's inventory yield — or revenue divided by inventory investment, a reflection of margin and product turnover — declined to 8.1 percent in 2000 from 9.2 percent in 1999 and 10.1 percent in 1998.

Finally, Slater points to the tremendous departure of a number of top merchandising, marketing and advertising executives at Gap over the past year and the negative impact these vacancies have had on Gap's merchandise and sales.

Bulls See Strength In The Numbers

The bulls, on the other hand, buy into Gap's staunch belief that with only a 6 percent market share of the extremely fragmented U.S. clothing market, there is tremendous growth potential for the chain's three lines for the foreseeable future.

GPS investors are also greatly encouraged by the creation of two new key jobs at Gap, a vice chairman and a chief marketing officer to oversee all three brands. With John Lillie now in place as vice chairman, CEO Mickey Drexler will be able to return to hands-on inventory and store oversight, says Pedro Verdu, director of research and an analyst on the AmSouth Large Cap fund, which has about 1.6 percent of its $100 million of assets in Gap shares.

"After 30 years of following the retail business, I've learned that the head guy has to have his eye on what in the stores, what's moving and that it's all going in the right direction," Verdu says. Drexler is well-regarded in the retail industry for his merchandising touch.

Others say that Gap's existing, prime real estate almost ensures its success — provided it gets the right merchandising mix. If there's one thing Gap has done well, it's been putting down stakes in highly trafficked areas.

Jonathan White, portfolio manager of the Stratevest Large Cap Core fund, brushes off Gap's missteps in 2000 as simply part of being in the trendy, cyclical fashion business. "The problems in 2000 were not major concerns because these are recurring problems for companies like Gap, and those missteps ultimately make it a buy," says White of the stock, now trading 54 percent below its $53.13 52-week high.

"Gap is a top-quality retailer that has an international franchise of considerable power," White says.