Is Gap A Value Or Value Trap?

By Ryan C. Fuhrmann | September 08, 2010 AAA

The last 10 years are widely referred to as a lost decade for equities given stock market returns have been flat over the period. This is also true of retailer Gap's (NYSE:GPS) stock, as well as its operations. More recently, growth trends are showing signs of life and the firm continues to generate impressive amounts of cash flow.
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Second Quarter Review
Gap reported second quarter results that saw sales rise a modest 2% to $3.32 billion as same-store sales increased 1% and online sales jumped 15% to $258 million. Operating income improved 5.9% to $397 million, or a very healthy 12% of sales. Higher income taxes tempered the bottom line increase to 2.6% for net income of $234 million, or 36 cents per diluted share. Also of note, Gap ended the quarter with $1.7 billion in cash on the balance sheet and no long-term debt.

By concept in North America, comps fell 4% at the company namesake stores but grew 2% and 3% at Old Navy and Banana Republic respectively. International stores are lumped in one operating unit and reported 3% comp growth.

Store Concept Review
Gap targets consumers with "moderate price points" and more basic apparel and competes with the likes of Ann Taylor (NYSE:ANN) and the clothing sections of Macy's (NYSE:M) or even JC Penney (NYSE:JCP). Old Navy pursues those interested in "value-priced family apparel" while Banana Republic chases after more fashion-conscious consumers at higher price points and competes with J Crew (NYSE:JCG).

Outlook
Management expects full-year earnings growth of 12% to 15% from the $1.58 it reported last fiscal year. Analysts currently project sales growth just over 2% to $14.5 billion. (For related reading, take a look at Can Earnings Guidance Accurately Predict The Future?)

Bottom Line
Over the past decade, Gap has managed 2% annual sales growth but a slight fall in net income over this timeframe. The top-line has fallen nearly 4% annually over the past three years, but management has found a way to generate more than 12% earnings growth, which has stemmed from cost controls and steady share buybacks.

It would be nice to see stronger sales trends, though recent results are somewhat encouraging. However, profit and cash flow growth has been impressive over the past few years. The forward P/E is also very reasonable at about 10, and the trailing free cash flow multiple is in the single digits. Given the robust bottom-line trends, shares of Gap are no longer the value trap they were earlier in the decade.

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