In line with other departmental stores, Gap Inc has been another retailer which bore a significant brunt of the coronavirus pandemic with its share price dropping from the highs of $18 per share to a low of sub-$6 levels due to shuttering of stores amid lockdown restrictions. The stock, however, made a raging pullback in the last one month, leapfrogging over 100% from its lows as the economy was set to reopen and the company began opening the stores. Gap operates over 3,300 stores across several brands including Gap, Old Navy, and Athleta with most of the stores being company-operated while few are franchised. But after the stupendous rally from the bottom, does GPS have further legs to climb higher?

Q1 Result Scanner

The company reported a worse than expected already abysmal results with sales tumbling 43% in Q1 against consensus estimates of 36% decline on the back of poor online takeoff which grew at just 13%. It reported a loss per share of $2.51 widely missing the consensus estimates which pegged at $0.34. Gap Global sales were down 50% with online sales down 5% while Banana Republic Global also could not drive up its online sales which ended down 2% with net sales down 47%. The silver lining was a steady uptake in performance of ON which reported online sales growth of 20% (while the net sales were down 50%) and Athleta with net sales down just 8% and online sales rising 49% as consumers increasingly turned towards active brands as they stayed home. Gross margin plunged to 12.7%, declining 23.6 percentage points, with merchandise margin accounting for half of it due to inventory writedown of $235 mn.

Q2 and Beyond

Management noted that they have been able to reopen about 1,600 stores (~55% of the fleet) and the stores are running down ~30% on average with Old Navy outperforming the average and Banana Republic running low. It noted that the company has experienced significant growth in its online sales 40% in April and 100% growth in May which is encouraging. However, the company's inventory was down just 1% and are resorting to a 'pack-and-hold' strategy like some retailers as management plans to sell the inventory next year at regular prices or flow it out as part of the chase strategy. This strategy is not proven and we remain skeptical, especially during such an uncertain time.

Summary

We expect the margins to decline a further 2-3 percentage points in Q2 and expect GPS to post a loss per share of $2.3 in 2020E with an EPS of $1.02 through 2021. We value the shares at 4.5x 2021 EV / EBITDA, a slight discount to its historical average given the uncertain environment, and ascribe a target price of $13.5 per share. Initiate at Neutral.

Data by YCharts