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Gap – back in fashion and back in your portfolio?

TikTok teens are reviving a fashion brand that only months ago looked as though it was in terminal decline
Gap – back in fashion and back in your portfolio?
  • After years of diminishing profits, Gap is reconnecting with young consumers
  • Recent strong performance by Gap's budget and sportswear labels also bodes well 
Tip style
Speculative
Risk rating
Medium
Timescale
Long Term
Bull points
  • Riding the Y2K fashion revival
  • Persistently low rating
  • Smaller labels discarded
Bear points
  • Squeeze on mid-priced clothing
  • Balance sheet much weakened

Once upon a time, kids would have dreaded having to wear their parents’ hand-me-downs. Today, mum and dad’s old threads are the hottest thing in fashion.

From crop tops to dad jeans, the early 2000s trends you thought were uncool are in vogue again. The wardrobes of Investors’ Chronicle readers may even have been raided by teenage offspring in recent months, as Gen-Z goes in search of the hottest brands of yesteryear.

Riding the wave of the so-called Y2K fashion revival is US retailer Gap (US:GPS), whose affordable jeans and hoodies were a wardrobe staple around the turn of the century. On TikTok, Gen-Z’s favourite social media app, videos tagged #GapHoodie have racked up 7.2m views.

Fashion commentators are largely attributing the brand’s comeback to young influencers such as Barbara Kristofferson, who in January posted a video of herself wearing a vintage brown Gap hoodie. The clip, which has been watched 1.8m times, has not passed the company by: “Our classic Gap hoodie is having a moment,” chief executive Sonia Syngal declared during a recent call with analysts. In June, Gap started selling a $60 (£44) version of Kristofferson’s brown hoodie, which by then was selling for four times as much on resale sites such as Depop, according to youth culture site Refinery29.

Gap, whose shares for years have worn a stubbornly low rating, may have been handed a surprise chance to reverse its fortunes. But can the TikTok trendsetters really revive the company, which only months earlier appeared to be in terminal decline? Or will its recent comeback turn out to be little more than this year’s fad?

 

Losing its cool

In a way, Gap’s youth culture moment is taking the company back to its roots. Founded in 1969 as a retailer of Levi’s jeans and pop records, Gap took its name from that decade’s notorious “generation gap” between unruly baby boomers and their parents.

The ensuing years were a story of steady growth, as Gap unveiled its own youth-conscious fashion line and expanded into new markets, developing the upscale Banana Republic brand in the 1980s before launching its affordable fashion label Old Navy in 1994. Gap’s flagship brand neared its peak around the new millennium, when supermodels such as Naomi Campbell – the influencers of the time – lined up to be snapped wearing its jeans. In the 1990s, the company’s share price soared more than 2,000 per cent.

But Gap began to show signs of ageing in the 21st century, as its mid-priced clothing was increasingly squeezed out of the market. Rich kids are now shopping more at luxury retailers such as Burberry (BRBY), which successfully rebranded themselves as youth culture labels. Others have flocked to fast fashion sites such as Asos (ASC), which sell the latest trends at a fraction of Gap’s prices. 

As retail moves online, Gap’s huge high-street footprint has also started to weigh on margins. Today, value label Old Navy is responsible for the bulk of Gap’s income, but it has been unable to curb declining profits across the group’s portfolio of brands. Gap released a profit warning in 2019, just four months before the outbreak of Covid-19 shuttered high streets around the world and further devastated the company’s cash position. Some 33 years after launching its first international store in London, Gap announced last summer that it would close all its remaining shops in the UK.

 

 

Yeezy does it

But as Gap’s UK stores were boarded up, the company was already laying the foundations for its makeover. Smaller labels Janie and Jack and Intermix have been sold off, after management unveiled a three-year plan to build on the “power” of the group's core brands: Gap, Old Navy, Banana Republic and sportswear label Athleta. 

Last June, Gap announced its namesake brand would be teaming up with Kanye West, the hip-hop star turned fashion designer who usually raps about luxury labels such as Prada (HK:1913) and Louis Vuitton. It may be hoping West’s Yeezy label can do for Gap what it already did for Adidas (DE:ADS), whose recent pick-up in sales has been partly attributed to a line of sneakers designed by the rapper. While the exact terms of Gap’s surprise deal have not been disclosed, the boost to brand value could be immeasurable: the company says 75 per cent of pre-orders for its recently released Yeezy jacket came from new customers.

Gap’s TikTok boost was less orchestrated by the company, but is also helping it reconnect with young consumers. As it steps away from the high street, Gap is capitalising on the opportunity to modernise its business: after reissuing its brown hoodie, it asked TikTok users to vote on which colour should be launched next. An overdue $140m investment in a new distribution centre for website orders was made in February, as part of plans to double the size of its online business by 2023.

The group is showing the first signs of new life. It recently reported its biggest second quarter for sales in a decade. Net revenue increased 5 per cent compared with the same period in 2019 to $4.2bn, while online sales surged 65 per cent to about $1.4bn. Investors are starting to warm to the company, sending the share price up more than 300 per cent from its pandemic lows.

 

Bridging the gap

But while fashion-watchers have their eye on Gap’s team-up with Yeezy, the performance of Old Navy could turn out to be an even more interesting story for investors. Affordable clothes have been popular during the Covid crisis and should continue to be as the economic impact endures: Gap said sales at Old Navy jumped 21 per cent in the second quarter, relative to the same three months in 2019. Investors have welcomed management’s decision to double back on plans to spin-off the value brand.

Indeed, rising profits at Old Navy, as well as at fast-growing Athleta, should help pay for essential but costly investments in ecommerce and the winding down of high-street stores. Gap says Old Navy and Athleta are “higher-margin” labels – although margin numbers are not broken down by brand in its most recent full-year results.

 

 

The new-found popularity of Gap’s namesake brand can also only be good news. In one promotional video posted on its TikTok page, a father and his teenage son are filmed while posing in the same Gap hoodie: a company that once made its name exploiting the “generation gap” should benefit from becoming a more diverse business, appealing to customers across generations and budget levels. While closing Gap stores, the group has actually been opening more Old Navy locations – shoppers in the value price range tend to be more attracted to physical stores.

Investors are apparently awaiting more signs that Gap is on the right track: despite the recent pick-up in its share price, the shares still trade at just 13 times forecast earnings for 2022 and the group's balance sheet is much weakened compared with just a few years ago. Even so, at such a low rating relative to its peers, we think now is an attractive time to buy in for believers in the company’s future.

 

Company DetailsNameMkt CapPrice52-Wk Hi/Lo
Gap, Inc. (GPS)$9.02bn$23.89$37.63 / $18.30
Size/DebtNAV per share*Net Cash / Debt(-)*Net Debt / EbitdaOp Cash/ Ebitda
$5.04-$4.65bn--
ValuationFwd PE (+12mths)Fwd DY (+12mths)FCF yld (+12mths)CAPE
102.8%6.4%10.2
Quality/ GrowthEBIT MarginROCE5yr Sales CAGR5yr EPS CAGR
6.4%--2.7%-
Forecasts/ MomentumFwd EPS grth NTMFwd EPS grth STM3-mth Mom3-mth Fwd EPS change%
97%16%-28.5%25.9%
Year End 31 JanSales ($bn)Profit before tax ($bn)EPS (c)DPS (c)
201916.61.3225572.7
202016.40.9919778.2
202113.8-1.06-1785.0
f'cst 202217.81.1322045.5
f'cst 202318.21.2925550.5
chg (%)+2+14+16+11
source: FactSet, adjusted PTP and EPS figures converted to £ 
NTM = Next Twelve Months   
STM = Second Twelve Months (i.e. one year from now) 
* Converted to £