Gap Stock: Stronger thanks to its digital-first approach (NYSE: GPS)
The global apparel industry is one of the industries hardest hit by the Covid-19 pandemic which has forced many businesses to close their stores. Two years after struggling to contain the pandemic, we are now seeing an improvement in global cases as following widespread vaccination. This is helping the industry recover, with experts predicting a Compound annual growth rate of 5.5% from 2021 to 2026.
The Gap, Inc. (New York Stock Exchange: GPS) is well placed to capitalize on growth Millennial population and Gen-Z. One of the company’s strengths is its investment in two technology companies named CB4 and drape; these investments are expected to help the company strengthen its competitive advantage in the area of digitization and skin in metaverse. Additionally, the company expects this will help improve the customer experience and support its revenue growth, particularly in its online sales. Its efforts to drive online sales and increase operational efficiency are acting as major catalysts, as GPS operating stores remain below the pre-pandemic level of 2,835 as of fiscal 2021. Its strategy Power Plan 2023 continues to bring significant improvement to the business, opening 32 Navy stores and 28 Athleta stores. In addition to this, GPS has also improved its liquidity, mitigating the risks associated with the uncertainties associated with the temporarily inflated cost of inputs. GPS is trading in a potentially overripe downtrend and is cheap at 19.87x the trailing P/E against its forward earnings of 7.11x.
Improve the top line
GPS ended its 2021 fiscal year with record sales of $16,670 million, a 20.8% increase over the previous year. That’s pretty impressive, especially considering its current count of 2,835 stores (up from 3,100 last year). This is thanks to its strong online sales, which are growing at a rate of 20% per year.
Online sales now represent 39% of GPS’s total revenue, up from 25% in fiscal 2019. According to management, their active customer base grew to 54 million in Q4 2021 from 45 million in the quarter. previous. With management’s “digital first” approach and the continued reopening of its operating stores, I believe GPS is poised to capitalize on its growing revenue forecast by analysts.
Strong Operating Margin
The management also reassures its investors on the management of their operating margin through an aggressive restructuring:
Over the past two years, we have undertaken a major restructuring necessary to become a more agile and focused company. With this, we have completed over 70% of the rationalization of our North American fleet with the closure of 250 stores, the transition of our European operations through capital efficient partnerships and the divestiture of small non-strategic brands. Throughout this time, we’ve leaned into a digital-first mindset. This resulted in fixed cost reductions in road and store costs. Source: Q4 2021 Earnings Call
The company is on track to free up a significant portion of its margin by focusing more on its profitable brand segment like Old Navy and Athleta.
The company’s operating margin increased significantly to 4.9% from 3.5% in fiscal 2019. Following the successful implementation of its Power Plan 2023 strategy and the anticipation of additional store closures, the company provided a bullish outlook for its operating margin. , which is expected to be between 6.3% and 6.8% in the next fiscal year, despite an inflated cost environment and supply chain issues. Contrary to its bearish catalysts of excessive supply chain disruption in China and high interest rates to fight inflation, the company is doing well as Asia region revenue is only 4.37% of its total revenue and the company has actually improved its level of debt. , reducing future interest payments.
Improve the level of indebtedness
GPS managed to reduce its long-term debt to $1,484 million, compared to its 2020 figure. As a result, this helped the company generate a debt-to-equity ratio improvement of 2.3x, better than 2.93x last year. Additionally, GPS has no long-term debt maturing before 2029, making it less sensitive to rising interest rates. In fact, management provided a better outlook on its net interest expense at around $70 million for the next fiscal year, an improvement from $162 million today.
According to my DCF model, the GPS has a fair price of $22.2. This implies good upside potential at the current price of $13.31 per share. After a huge decline from its 2022 high of $37.63, GPS is currently trading at a trailing P/S ratio of 0.30x cheaper than its 5-year average of 0.57x. Moreover, it is trading low with its P/E ratio of 19.87x and forward earnings of 7.23x. At the time of this writing, an implied P/E ratio of 8.86x below the current sector median of 12.99x can also provide a significant upside, as illustrated in the image above. Moreover, taking into account both and averaging the two, we get a potential upside of 48% at today’s price.
I completed my DCF model with the help of an expert forecast. I expect its operating margin to continue to improve to 6.7% at the end of the model. A failure on its 2022 tax margin of 6.3% will have a negative impact on my model, which investors should watch. In fact, management was forecasting aggressive growth from its 5-year average of 3.94% (in reported numbers). I projected an increasing effective tax rate of 29% in 2024 assuming less impact on future disposals.
Above are my assumptions, WACC calculations, and selected 5-year historical data that I used to complete the model.
Potential Bear Exhaustion
GPS is currently on its 5th potential wave as shown in the chart above. According to Elliott Wave Theory, the 5th wave is already a mature trend and basically tells investors and traders that we might see a corrective wave before another rally sets in. A break of its $15 will break a strong bearish pattern and we could see a shift in sentiment from bearish to bullish. In this case, I think the GPS is set to print a bullish setup and its first impulse wave at around $18. In my view, a drop below $10.5 is an area of high demand to watch. Looking at its simple moving average indicator, we could see its price reversing its 20-day simple moving average and a break of it could imply bullish price action, which will add confluence to my bullish thesis. The GPS has also already printed a bullish MACD crossover, indicating weakening bearish prices over the next few weeks of trading. Currently, GPS has an improving short interest, however, it remains high at 15.27% to date.
Despite its short-term headwinds, GPS has maintained liquidity, which I believe is a positive catalyst in today’s uncertain environment. Its powerful catalyst in growing its online sales and the successful implementation of its Power Plan 2023 will enable the company to increase its margins while maintaining a constant and growing turnover. Based on its projected cash flow and cheap valuation, this company has favorable upside potential. Finally, GPS is trading at a logical support level and offers a strong risk-reward ratio, which makes this stock worth taking a risk.
Thanks for the reading. Cheers!