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Bear Of The Day: The Gap Inc. (GPS)

The hustle and bustle of Main Street had once been the fuel for prosperous brick-and-mortar retailers, but the pandemic and the economic lockdowns that came with it turned every major city into a ghost town, leaving the already antiquing storefronts to either digitalize (aka ecommerce) or die.

The retail apocalypse, which began as a slow transition to the web with Amazon AMZN leading this digital transformation, was accelerated by years amid the lockdowns, allowing investors to easily distinguish between "the good, the bad, and the ugly" of this economic shift.

The Gap Inc GPS, the parent company of Old Navy, Banana Republic, Athleta, & its namesake brand, have been an unsurprising victim of this digital shift away from Main Street. The company has been frantically restructuring its business model since the pandemic began, as it makes every effort to adapt to the new normal.

Gap had previously made plans to spin off its best-positioned subsidiaries: Athleta & Old Navy, in early 2019. However, it needed every bit of scale it had to keep its operations afloat once the pandemic began. Its latest strategy (Power Plan 2023) consists of closing hundreds of its less productive Gap and Banana Republic storefronts and has closed nearly 20% of its global stores since the pandemic began, while at the same time, investing and expanding its global footprint in Athleta & Old Navy. The company plans on openings 20-30 and 30-40 new stores, respectively.

The question is whether this diverse mix of legacy and growth brands can continue successfully executing this high-margin growth strategy?

Unsustainable Growth?

GPS came into 2021 with an unexpected digitally-powered tailwind, and Old Navy and Athleta were at the core of its margin expanding success. These two brands have become The Gap's pillars of high-margin growth, accounting for 65% of this business's total sales in its first 3 reported 2021 quarters.

Altheta's appealing women's athleisure and competitive 'budget offering' relative to its biggest competitor Lululemon LULU, make it uniquely positioned for the new normal. Old Navy's modestly priced clothing was an attractive offering for working moms during the pandemic lockdowns, with no reason to spend more than needed on clothes (for both them and their kids) that no one but the fam will see.  

However, this bullish sentiment about the company has begun to dissipate. The latest results from these two growth drivers show significant decelerations, pushing analysts back on their heels as estimates and price targets get reeled in.

GPS has fallen to a Zacks Rank #5 (Strong Sell), and this falling knife looks like it still may have more room to fall, even after its 25% post-earnings capitulation at the end of November.

Final Thoughts

The Gap is trading at half of the value that it peaked at last May and looks like it could continue lower. The company's "Power Plan" strategy puts the business on track to spend $800 million per year through 2023 to "support growth investments including digital, loyalty, and supply chain capacity projects."

If this strategy doesn't achieve the earnings growth it's targeting, this plan could end up being an unwanted weight on Gap's ability to turn positive cash flows. The firm hasn't been able to break $800 million in earnings since 2018.

GPS managed to rally almost 400% from its low in May of 2020 to its high 52-weeks later. Optimism about the future of Athleta and Old Navy were the primary drivers, and their sudden deceleration in the most recent earnings is cause for significant concern.

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