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Can Gap (GPS) Return to Growth in 2021 on Solid Online Show?

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The Gap, Inc. (GPS - Free Report) has been witnessing sluggish store traffic due to the COVID-19 pandemic. As a result, management decided to shut down a few underperforming stores, which is likely to be concluded in fiscal 2021. Also, adverse product mix due to the shift in consumers’ changing preference to more casual fashion in sync with the current stay-at-home trend weighed on in the performance of its Gap Global and Banana Republic Global brands. Cumulatively, in-store sales declined 20% in third-quarter fiscal 2020.

Further, the company has been incurring expenses related to health and safety measures at stores along with higher shipping expenses to fulfill the increased online orders. As a result, operating expenses rose 8% in the fiscal third quarter, with the operating expense rate up 270 bps to 36.2%. Alongside this, elevated marketing expenses across all brands dented bottom-line growth and margins in the fiscal third quarter. Moreover, the operating expense rate is expected to rise 33-34% in fourth-quarter fiscal 2020.

These headwinds have led the Gap stock to underperform the industry and the Retail-Wholesale sector on a year-to-date basis. Shares of this Zacks Rank #3 (Hold) company rose 15% compared with the industry’s growth of 36.6% and the sector’s 36.4%.

Factors That May Turn the Tables in 2021

Robust online growth is now serving as the much-needed cushion to Gap’s top line with significant contributions from the Gap, Old Navy and Athleta brands. Notably, e-commerce sales improved 61% in the reported quarter, representing about 40% of its net sales in the fiscal third quarter. Further, its e-commerce business acquired 3.4 million new customers in the said quarter. Encouragingly, management is investing more in online shipping capabilities and curbside pickup options, which is likely to have contributed to a robust holiday shopping season. Evidently, it expects fourth-quarter fiscal 2020 net sales to be equal to or slightly higher than the year-ago quarter.

Moreover, management remains optimistic about its powerhouse brand — Old Navy — driven by better execution of its unique value equation and positioning, with style, fit, quality and price, all working in balance. Net sales for the Old Navy brand improved 15% in the fiscal third quarter, with comps growth of 17%.

Moreover, the Athleta brand has been a bright spot for the company as consumers are buying more comfortable apparel due to the pandemic-led stay-at-home trend. This activewear brand with increased digital marketing investments and focus on product strategy has been aiding sales. In third-quarter fiscal 2020, Athleta’s net sales were up 35%, with comps growth of 37%. Topping it, Athleta recorded the highest comps growth in the brand’s history, including more than 50% contribution from the online business. The brand also benefited from continued demand for its masks, which helped establish new customer engagements across other product offerings.

Moreover, Gap remains on track with the execution of its Power Plan 2023, which focuses on opening highly-profitable Old Navy and Athleta stores. As part of the plan, the company expects the Old Navy and Athleta brands to contribute about 70% of sales by 2023. In sync with its fleet optimization efforts, the closing of underperforming Gap and Banana Republic stores is anticipated to realize $100 million in EBITDA savings on an annualized basis by the end of 2023. It also envisions the e-commerce business to contribute 50% of sales by the end of 2023 on the back of higher investments in digital, technology and distribution capacity.

Wrapping Up

Despite weak store traffic, which is likely to persist, we believe that turnaround efforts, including investments in digital capabilities, expansion of the Old Navy and Athleta brands, store optimization and increased focus on consumers buying behavior, are likely to bring the stock back on the growth trajectory. In fact, the Zacks Consensus Estimate for earnings in fiscal 2021 is pegged at $1.29 per share, reflecting a rise of 16.2% in the past 60 days. These factors raise investors’ optimism on the stock.

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