The retail industry has grown remarkably over the past year on the back of increasing demand for online shopping, and immersive experiences offered by digitally sophisticated retail stores. While most stocks in the sector are thriving, there are some significantly overvalued players that Wall Street analysts detest. Cases in point are Gap (GPS) and Abercrombie & Fitch (ANF). Their weak fundamentals do not justify their premium valuations. Hence, we think they should be avoided now. 

The COVID-19 pandemic has changed the retail landscape in a big way as consumers learned to depend much more on online shopping and physical retailers responded with speedy rollouts of new and advanced online shopping facilities. While brick-and-mortar retail has been dying a slow death at the hands of growing e-commerce trends, retailers equipped with omnichannel offerings have witnessed steady growth.

Investors’ confidence in the retail industry is evidenced by the SPDR S&P Retail ETF’s (XRT) 137.8% returns over the past year versus the SPDR S&P 500 Trust ETF’s (SPY) 39.9% gains over this period.

Furthermore, retailers offering personalized customer experiences should continue to experience accelerated growth in their businesses. Although the economy’s reopening and strategic changes in business models have been helping some retailers gain considerable traction, stocks such as The Gap, Inc. and Abercrombie & Fitch Co.  are trading at lofty valuations despite possessing weak fundamentals. As such, Wall Street analysts are bearish about their growth prospects. So, we think they are best avoided now.

The Gap, Inc. 

Founded in 1969, GPS is an apparel retail company. It sells its products under the Old Navy, Gap, Banana Republic, Athleta, Intermix, and Janie and Jack brands. Its products include denim, tees, jewelry, shoes, handbags, and fitness and lifestyle products. As of March 04, 2021, the company had 3,100 company-operated stores and 615 franchise stores.

This month, GPS agreed to sell Intermix, a leading omni-channel fashion boutique, to private equity firm Altamont Capital Partners. Altamont intends to acquire the entire Intermix business, including all store leases, e-commerce and assets. This move should reduce GPS’ revenue stream and affect its financials.

GPS’ forward P/E currently stands at 23.35x, 26.5% higher than the 18.45x industry average. The company’s 760.03 trailing-12-month EV/EBITDA is 5178.7% higher than the 14.40x industry average.

GPS’ net sales declined by 5.4% year-over-year to $4.42 billion in the fiscal fourth quarter ended January 30.Its gross profit declined 0.4% year-over-year from its year-ago value to $1.67 billion, while its net cash from operating activities declined 83% from its year-ago value to $237 million.

Closing yesterday’s trading session at $32.82, the $32.43 consensus price target for GPS represents a potential downside of 1.3%.

GPS’ weak fundamentals are reflected in its POWR Ratings. It has a D grade for Growth and Stability, and a C grade for Quality. Among the 65 stocks in the B-rated Fashion & Luxury stocks, it is ranked #46.

We have also graded GPS for Sentiment, Value and Momentum. Click here to see them.

Abercrombie & Fitch Co. 

ANF is a global specialty retailer. The company operates in two segments, Hollister and Abercrombie. It offers an assortment of apparel, personal care products, intimates, and accessories for men, women, and children under the Hollister, Abercrombie & Fitch, Abercrombie kids, Moose, Seagull, and Gilly Hicks brands. As of May 28, 2020, it operated approximately 850 stores.

In terms of forward non-GAAP P/E, ANF is trading at 23.10x, 28.9% higher than the 17.92x industry average. The company’s trailing-12-month EV/EBIT of 793.12x is 4210.6% higher than the 18.40x industry average.

In its fourth fiscal quarter, ended January 30, ANF’s sales declined 5.1% year-over-year to $1.12 billion, while its gross profit declined 1.5% year-over-year to $679.02 million. The company has reported an operating income of $115.9 million, representing a 5.3% decrease from its year-ago value. ANF’s EPS came in at $1.27 for the quarter, compared to $1.29 in the prior-year quarter.

Analysts expect ANF’s EPS to decrease 43.5% for the next quarter ending June 2021. The company’s stock has declined 1.1% over the past month.

Closing yesterday’s trading session at $37.49, the consensus price target of $36.67 for ANF represents a potential downside of 2.2%.

ANF’s poor prospects are also apparent in its POWR Ratings. The stock also has a D grade for Stability, and a C grade for Growth and Sentiment. Click here to see the additional POWR Ratings for ANF. (Momentum, Quality and Value).

ANF is ranked #27 of 65 stocks in the Fashion & Luxury industry.

GPS shares were trading at $32.54 per share on Friday afternoon, down $0.04 (-0.12%). Year-to-date, GPS has gained 62.47%, versus a 11.35% rise in the benchmark S&P 500 index during the same period.