I’ve written it before, and I’ll write it again. And will continue to do so ad nasuem: when it comes to Gap Inc., don’t believe the hype.
It’s easy to forget this, especially when reading recent raves about the retailer’s December ’12 numbers (and the corresponding jump in stock price).
To wit: in early January, the company “reported that December 2012 net sales increased 5 per cent compared with last year,” up to $2.08B net sales from $1.98B from the five-week period ending December 31, 2012. Most markedly, Old Navy (the North America division) posted a 13% increase in 2012 (vs. just 4% last year).
Finally, the market “believes” in the Gap story again, trading the stock at more than $33/share after a 52-week low of $21.15 (though down from a same-time high of $37.85).
Despite positive Q4 earnings reports and the market’s confidence, however, Gap is still in trouble, still headed in the wrong direction.
Here are 3 reasons why you should (still) be betting against the retailer (and its purported “turnaround”):
1) Look from whence comes the growth: As spiriting as Gap’s numbers appear at the outset, the devil is in, as in all things retail, the details. Most significantly, it’s important to look at through which division this increase in revenue emerged this holiday season: more than the Gap or Banana Republic brands, Old Navy posted the highest same-store-sales increase over the holidays, and really, it all makes sense. Reflecting the global economic realities now hitting America’s shoppers’ wallets, ON’s bump in sales drove revenue for Gap Inc., but at a “price:” the lowest-price point retailer in the Gap roster also posts the lowest margins, ergo demanding higher revenue and faster turns for the inexpensive chain (while simultaneously training Gap customers they can purchase clothing similar to the Gap’s and BR’s at a far more inexpensive price). Consequently, while Gap’s overall revenues increased, they did so at the “lowest level” of the margin chain, thereby squeezing profit margins and pushing the Gap brand “up-market,” a market-space in which GAP has historically gained thorough criticism and lost traditionally-loyal consumers.
2) Growth…in the wrong direction: This brings us to Gap’s recent $130MM acquisition of luxury-brand boutique Intermix Holdco, “a deal that will give the mostly casual-clothes retailer an opening to the all-important luxury market.” While company executives explain that this is simply an “extension of the Gap’s move into the multi-brand, premium arena initiated with its 2010 purchase of Piperlime.com,” the move is, in short, a disaster in strategy and demonstrates conclusively that Gap has lost its way. Once the retail world’s “go-to” growth story, Gap has since floundered (the exception being 2012’s stumbled-upon fashion must-have of brightly-coloured, light-fabric pants that corresponded serendipitously with a historically-warm year), losing focus on the operational and financial discipline that’s necessary to manage a company that’s since peaked. In short, by using Intermix to expand into the high-priced exclusive marketplace, Gap is essentially relegating its title brand to the retail sidelines.
Now, will some consumers hit BR and Intermix for higher-end, more durable product while others (like myself) frequent ON for less-expensive jewelry and variations on the t-shirt and jeans aesthetic? Yes, of course. Gap owns these spaces – at the high and low end. But therein lies the problem. As one consumer recently observed to me, “I look at Banana Republic and think, ‘I’d like to dress like that, but it’s too expensive.’ So I go to Gap, but see what looks like to me cheap, Banana Republic knock-offs at still too expensive prices. So I just go to H&M or Zara, because I know what I’m getting.” And that’s the crux of the issue: by attempting to be all things to all people, Gap is doing a significant disservice to its titular brand, by driving customers who would traditionally and loyally shop at Gap to head over to its competitors, while spending fewer dollars at Gap’s “ancillary” stores/brands. In short, by trying to be “all things to all people,” Gap is training shoppers to avoid its “central” brand, driving them to BR and ON (and, now, Intermix).
3) Europe failed, so let’s try the BRICs!: After executing an ill-fated, poorly-timed expansion into Europe in the mid-2000’s (a move the company followed up with further expansion in 2011), Gap’s at the expansion game again, this time focusing in particular on China and Brazil – 2 countries of the BRIC “coalition” which have posted some of the highest growth GDP numbers in recent years. As it did with its expansion into Europe, GAP has massively mis-timed this move, migrating into these markets just as they’re set to contract. To point: China faces significant economic and political risks and perils in the next few years, as the Eurozone (a significant trading partner) enters its 4th year of crisis. Furthermore, China’s debt bomb is set to explode, as “‘Chinese banks have rolled over at least three-quarters of all loans to local governments that were due to mature by the end of 2012.'” In short, as China prepares itself for slower growth and an inevitable contraction within the next few years, fewer Yuan will be spent on discretionary retail goods, a fact that’s colliding immediately with Gap’s China expansion plan.
Furthermore, Brazil looks no better for Gap’s growth aspirations. 2013 will most likely be an ugly year for the country, with the world’s 6th largest economy facing electricity rations and liquidity pressures. Furthermore, Brazil’s GDP growth trends have been on the downslide for the past few years, dropping from 7.5 per cent in 2010 to 1.5 per cent last year, suggesting an economy on the brink of stagnation. In short, by jumping into one-half of the BRIC waters in 2013, Gap is grasping at the wilted straws of emerging market retail growth. Look for this expansion plan to bleed profits from the retailer in 2013 and beyond.
So there we have it. Is Gap permanently doomed? No. But don’t call this a comeback – or even a turnaround. Gap still has a long way before it finds its way.
Margaret Bogenrief is a partner with ACM Partners, a boutique crisis management and distressed investing firm serving companies and municipalities in financial distress. She can be reached at [email protected]
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