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Here's Why You Should Hold on to Gap (GPS) Stock for Now

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With the retail industry on the road to recovery, Gap, Inc. (GPS - Free Report) is witnessing renewed momentum on the back of strength in its Old Navy and Athleta brands as well as continued momentum in the online business. Also, its Power Plan 2023 strategy bodes well. This led to better-than-expected first-quarter fiscal 2021 results, wherein earnings and sales improved year over year. Moreover, it reported strong growth in key metrics on a two-year basis (compared with first-quarter fiscal 2019), reflecting robust growth from the pre-pandemic levels. Further, the reopening of the majority of stores aided sales. Driven by these factors, shares of this Zacks Rank #3 (Hold) company have surged 66.7% year to date, outperforming the industry’s growth of 33.6%.

That said, let’s delve deeper into the factors aiding the stock.

Growth Drivers

Gap’s powerhouse brand, Old Navy, which is focused on creating affordable high-quality fashion, remains a key catalyst. Notably, the Old Navy brand has been witnessing a significant acceleration in the digital business on the back of robust customer demand and relevant digital marketing investments. Additionally, Gap has been experiencing significant progress in its smaller brands. Notably, the Athleta brand’s value-driven active and lifestyle categories, increased digital marketing investments and focus on product strategy have been aiding sales.

In first-quarter fiscal 2021, net sales improved 27% and 56% for the Old Navy and Athleta brands, respectively, from the pre-pandemic levels. Comps at Old Navy Global and Athleta increased 25% and 46%, respectively, from the 2019 comparable period. Also, continued momentum in casual and cozy categories, with sturdy performance in active and fleece, contributed to Old Navy’s quarterly sales.

Moreover, the company’s digital business has been performing well since the onset of the pandemic. Despite the opening of stores, the company continued to witness strength in the online business, with digital sales increasing 61% year over year and 82% from the first quarter of fiscal 2019. Notably, the digital business contributed 40% of total sales in the reported quarter. Continued growth in the e-commerce business contributed significantly to the company’s consolidated sales as well as gains in its Gap, Old Navy and Athleta brands. Further, it launched its native Android app in March, which is gaining traction. Moreover, alternate payment options, including PayPal and AfterPay, represented 20% of online spend in the fiscal first quarter. Consequently, management remains keen on optimizing its mobile experience as a key priority in 2021.

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Encouraged by a strong start to fiscal 2021, Gap raised its view for the year. It now envisions adjusted earnings of $1.60-$1.75 per share compared with $1.2-$1.35 mentioned earlier. The company expects year-over-year sales growth in the low-to-mid twenty percent range compared with mid- to high-teens stated earlier. Moreover, the company expects a reported and adjusted operating margin of 6%, up from 5% mentioned earlier. The Zacks Consensus Estimate for fiscal 2021 earnings is pegged at $1.71 per share, reflecting an increase of 2.4% in the past 30 days.

Apart from these, it remains on track with its Power Plan 2023, which focuses on opening highly profitable Old Navy and Athleta stores while closing the underperforming Gap and Banana Republic 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 plan, the company intends to close about 100 Gap and Banana Republic stores globally, net of openings, in fiscal 2021, in line with its Power Plan 2023 strategy. This is likely to result in EBITDA savings of $100 million on an annualized basis by the end of 2023. Also, the e-commerce business is likely to contribute 50% of sales by the end of 2023.

Headwinds to Overcome

The company has been grappling with a significant rise in marketing expenses across all brands. Looking ahead, it anticipates a higher SG&A spend, as a percentage of sales, in the second quarter of fiscal 2021, on a sequential basis. Additionally, increased investments in customer-facing technology to support the integrated launch of its loyalty program in the fall are likely to result in the SG&A expense increase. Moreover, the loss of in-store sales for the past few quarters, led by COVID-related store closures as well as the permanent closures of the Gap and Banana Republic brand stores, as part of the Power Plan 2023 strategy, remains a concern. Despite improved traffic trends owing to reduced restrictions and the reopening of most stores worldwide, in-store sales continued to decline in first-quarter fiscal 2021.

Bottom Line

Despite the cost woes, robust business trends in the apparel industry, a solid online show and strength in its Old Navy and Athleta brands are likely to help Gap sustain the momentum.

Stocks to Consider in the Retail Space

Abercrombie & Fitch (ANF - Free Report) flaunts a Zacks Rank #1 (Strong Buy) and an expected long-term earnings growth rate of 18%. You can see the complete list of today’s Zacks #1 Rank stocks here.

L Brands currently has a long-term expected earnings growth rate of 13% and a Zacks Rank #1.

Hibbett (HIBB - Free Report) , also a Zacks Rank #1 stock, has an expected long-term earnings growth rate of 17.7%.

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