INVESTMENT

PROPOSITION

GPS | The Gap Inc.

As of October 31, 2014

Mutual Investment Club of Cornell

Recommend Long at Target Price $45.6

INVESTMENT
PROPOSITION

Table of Contents

INTERNAL ANALYSIS

RECENT DEVELOPMENTS

COMPANY OUTLOOK

10

FINANCIAL VALUATION

11

COMPETITOR ANALYSIS

13

INVESTMENT
PROPOSITION

Investment Thesis

Gap continues to sustain profits barring a transition phase to revitalize their brand and expand globally.
It is a recommended buy with a target price at around $45.6 within the next 12 months

1/

New Image

Key Investment Drivers

Repurchase of Stock in 2011

New creative director, campaigns to revitalize Gap and

international expansion catered to selling the iconic American
style

GPS Stock Price

July 2010-October 2014
50
40

2/ Operational Efficiencies
Margins expected to improve due to fabric platforming, seamless
inventory, and reduced costs

30

The undervalued new CEO, effective in 2015, can successfully

drive the omni-channel platform through cutting-edge consumer
engagement techniques

Upward
trend

20
10
23-Jul-10

3/ Management

Repurchase of
stock

23-Jul-11

23-Jul-12

23-Jul-13

23-Jul-14

In 2011, Gap emmited long-term debt for $1.646B,

and used it to repurchase stocks for $1.323B. The drop
in number of stocks with a minimal effect on profits
led to a rise in stock price by ~70%.

Financial Analysis

The company shows strong sales, stable operational margins (reflected by their profits)
Operations are concentrated in the US, represent 80% of their income, the rest consists of Asia, Canda and Europe
Has a seasonal behavior, excelling in sales at the end of the year
The behavior of the price of the stock is in line with the market given its current price is 80% of its maximum price over the
last 52 weeks; the mean of the key competitors is ~ 77%
Great stability and level of ROE and Multiplier values

ROE>40%

Multiplier Value>6x

The market is mistaking short term uncertainty for long term instability. Gap has convincing expansion
potential that Peck is uniquely skilled to realize.
3

Executive Summary

INVESTMENT
PROPOSITION

Gap is a leading diversified retailer with strong international growth potential focus on consumer
engagement
Key Statistics 2014

3,100 stores | 80 countries (40 online-only)

Sales: US=77% | ASIA= 9% | CAN=7% | EUR=6%

40

Revenue Breakdown2 and Growth

In USD, 2011-2013

5.12%
CAGR

30

Industry

15% market share in Family Clothing |Top Competitors: TJX

(15%) & ROSS (11%)

6.01%

20

1.62%

9.40%
24.44%

10

Segment Breakdown

18% Banana Republic | 37% Gap | 41% Old Navy | 4% Athleta,

Piperlime, and Intermix

USA
Gap

Canada
Old Navy

Europe

Asia

Banana Republic

Others
Other

Strengths: 1/ Global Expansion 2/ Omni-Channel 3/ New Brand

Financial Overview

2 Year Stock Chart

Expectations

In USD, January 2013-October 2014

50

GAP

Past Performance

40

Equal Weightage
Portfolio1

30
20

Jan-13

4.53% 5yr Revenue Growth CAGR3 | $25 million marketing expenses

| $750 million global expansion capex4

1.
2.
3.
4.

Apr-13

Jul-13

Oct-13

Jan-14

Apr-14

Jul-14

Oct-14

Q2 FY14 Net Sales grew 3% YoY | 11% 2yr share price CAGR | $0.88
dividend in 2014 compared with $0.50 in 2012

E-Commerce Platform

Online sales grew 21% in 2013 | 14% of revenue in 2013, 7% of

revenue in 2008

Portfolio consists of Lululemon, Aeropostale, American Apparel, TJMax, Express

Natural Logarithm of Revenue Taken to normalize graph
Based on DCF assumptions
FY14 Q2 Earnings Call

INVESTMENT
PROPOSITION

Overview of Gap

Economics recovery and drop in consumer price sensitivity bode well for Gaps opportunity to grow and
capture market share through brand reestablishment
Breakdown of Gap by segments

INTERNAL ANALYSIS

Other

Athleta is the fastest growing segment.

This active wear brand directly competes
with Lululemon
Piperlime- online only fashion boutique
that recently opened its first physical store
in Soho in 2012

4%

18%

41%
37%

Luxury brand with new aims to develop a

360 Lifestyle with clothes no longer
centered around work

Caters to value shopping which makes

up 40% of US apparel sales
Has an affordable family apparel feel that
will appeal to family-oriented culture in its
new Asian expansions
New designer Rebekka Bay
Past and current executives agree that
emphasizing Gaps classic brand instead
of chasing after rivals designs is the best
way to keep in touch with the customer

Economic Drivers for Consumer Demand1

Disposable Income dictates the willingness of consumers to purchase clothes from differing brands
US recession 08: leads to purchase of second-hand clothes
Function over fashion mentality
Recovery in economy reduces price sensitivity by consumers, e-tailors provide alternatives for customers
Added responsiveness to advertising campaigns
Fashion over function
1. IBIS World Analysis, Thomson One Industry Reports

INVESTMENT
PROPOSITION

Understanding the firm and its surroundings

Gap owns iconic brands across all price points, insulating it from short-term trends
Breakdown of Gap by segments
SSS Increase: XX% | Athleisure and Boutique

4%

INTERNAL ANALYSIS

Athleta Strengths: Fastest growing segment,

stealing market share from Lululemon brand
Piperlime Strengths: online-only store with pop
up store in So-Ho

SSS Increase: X% | Luxury

Other

18%

Weakness: Highly competitive market

41%

SSS Increase: X% | Value

Strengths: Mobile Engagements, TV Ads,
expanding lines, affordable family apparel feel
in growing Asian markets
Weakness: Lose demand due to fashion over
function shift

Strengths: New aims to develop 360 Lifestyle,

Successful social media market techniques,
new former Jcrew designer Marissa Webb

37%

SSS Increase: X% | Evolving

Strengths: Classic American Clothing,
Integrated E-Commerce platform, Brand
Revitalization

Economic Drivers for Consumer Demand1

Disposable Income dictates the willingness of consumers to purchase clothes from differing brands
US recession 08: leads to purchase of second-hand clothes
Function over fashion mentality
Recovery in economy reduces price sensitivity by consumers, e-tailors provide alternatives for customers
Added responsiveness to advertising campaigns
Fashion over function

Economic recovery and drop in consumer price sensitivity bode well for Gaps opportunity to grow and
capture market share through brand reestablishment
1. IBIS World Analysis, Thomson One Industry Reports

INVESTMENT
PROPOSITION

Supply Chain Efficiencies

Gap leverages its size and scale to decrease unit cost and response time
Gap has created a better system to allow international expansion without increasing COGS and future
earnings will reflect this in increasing operation margins

INTERNAL ANALYSIS

2009-2013
Unable to improve margins
39% in 2013 compared to 40% in 2009

2013 onwards
COGS include Occupancy Expenses, Promotional
Activity, and Materials
Focusing on reducing material cost
50% of merchandise will use efficient model by
2016

Fabric Platforming

A new supply chain solution that shifts

relationship from vendor based to mill based
Better aligns inventory with demands and
reduces COGS
With this strategy, lead time will be cut in half
by 2016 to allow quick trend response

Cotton Prices and Future Outlook

Seamless Inventory
Currently: Inventory is allotted to different countries
when it leaves the vendor inefficiencies in
inventory allocation
In 2015: Gap will implement global labels allowing
them to sell and move products across markets1
7

1. Gap 2014 Investor Day Report

Anticipation oscillation of revenue and

diminishing assistance will lead to volatile
revenue
Annual Growth is 3.0%
Projected Growth 2.2%
Key drivers:
Subsidies for cotton
World price of cotton
Natural disasters
Prices for synthetic fibers
US=Top exporter of cotton
Highest subsidies

Omni-Channel Retail Strategy

INVESTMENT
PROPOSITION

Gap continues to overcome all technology challenges, organizational silos, and operational issues that
thwart 94% of retailers to maintain a successful omni-channel retail strategy

INTERNAL ANALYSIS

Consumer Expectations1

Competitors1

1. 86% of Gaps purchases

are made in-store
2. 61% of customers highly
value sales associate

1. 3,100 stores worldwide with

continued global expansion
2. Gap has increased the
minimum wage to $10.10 to to
enhance the consumers
customer service experience

1. Many retailers are going

global to capture
demand for US products
2. 34% report limitations by
staff skills

Online

1. 39% are unlikely to visit

store if store inventory
isnt available online
2. 66% find benefit from
recommendations based
on past purchases

1. Find in Store option so users

can pre-browse online
2. CEO Peck plans to use big
data collection to unveil a
personalized online-market
strategy2

1. Only 32% have real-time

store inventory
2. 72% they are facing
difficulties approaching
personalization3

Both

1. 50% expect to buy online

& pick up in store
2. 84% are likely to buy in
store and ship to home
3. 2/3 of online purchases
utilize the store

1. Reserve in Store available in

Gap and BR stores
2. Kiosks allow for home delivery
3. Athleta: Click to Brick
company opened 65
additions since 2013

1. Reserve in Store feature

grew 12% in 2012
2. Still an infant tech
3. Athleta leads market as
#1 US Store count for
Click to Brick retailers4

Brick and
Mortar

1.
2.

Gap

3.
4.

Statistics from Minding the Omni-Channel Commerce Gap, by Forrester Consulting, commissioned by Accenture
Consider also:

A. Unlike many competitors, Gap constructed their e-commerce technology in-house which gives them the flexibility and scalability
Benefits of Web Personalization, Monetate
On Solid Ground, ATKearny Report

INVESTMENT
PROPOSITION

The new CEO for the new retail challenges

Drastic reaction towards change of CEO is predictable based on historical data, Art Pecks experience and
insights are essential to Gaps growth and can provide company with solutions to current obstacles
Art Pecks Profile

RECENT DEVELOPMENTS

A Digital
Leader

Gap Inc. Stock Price

CEO effective February 1, 2015

Harvard MBA and BCG Senior
Partner Alumni
Since 2012, served as president of
Gaps Growth, Innovation, and
Digital division
2008-2011, Head of Outlet divisions
and led expansions into Canada
and Europe for the first international
footprint

In USD, Sep. 2, 2014- Oct. 21, 2014

50
45

14.67% drop when CEO replacement

was announced

40
35
30
2-Sep 9-Sep 16-Sep 23-Sep 30-Sep 7-Oct 14-Oct 21-Oct

Concerns: Analysts are reacting negatively to the change in management because Pecks lack of merchant experience will fail
to fight retail pressures the way former CEO Glen Murphys could

A response thats been seen before

Previous CEO change led to a 12% stock price drop, when Glen Murphy assumed the role in August 2007, followed by a notgrowing period (financial crisis?), and then by a sustained growth in a relatively healthy economy

What do we see in Art Peck?

1/

Selection of Art Peck indicates a realized importance on innovation and digital presence. Peck is most qualified to grow
Gaps crucial omni-channel platform faster than its competitors.

2/

Peck has a record of high performance. During his tenure, he acquired Intermix, and opened over 80 stores for Athleta,
formally a online-only company, to benefit from the omni-channel platform

3/

Plans for international expansion, personalized recommendation online, and a fabric platform which better aligns
inventory with sales in each period

INVESTMENT
PROPOSITION

Gaps New Image

Gap finds that its new branding strategy intended to emphasize Gaps classic brand instead of chasing after
rivals designs is the best way to keep in touch with the customer
Rebekka Bay
Background: Gaps creative director since 2012- her experience designing for H&M and trend
predicting ability make her a perfect candidate to turn around Gaps momentum.

RECENT DEVELOPMENTS

Idea: With a minimalist view, Bay believes that the iconic Gap pieces such as khaki, denim, and T-shirts
are all it needs to draw back consumers. Plans to play on the emotions of buyers, connecting them
with the familiar and timeless style of Gap. Her team includes former J.Crew designers who can
translate her minimalist vision into something sellable.
Implementation: Gap launched campaigns intending to remind consumers of its heritage feel.
Campaigns featured non-traditional models being themselves in Gap clothing. Latest ads featured
rappers, English professors, and a Sikh man all enjoying their timeless Gap clothing.

Key Rebranding Events

2012: Gap goes digital as they target social
media and blog platforms where users can draw
inspiration.

2011

2012

Feb 2011: Chief designer Robinson is fired and Gap Global

Creative center is created in NYC. Stock appreciates 15%

10

Nov 2013: Make Love- culturally inclusive holiday

campaign. 6% stock appreciation.

2013

2014

Sept 2013: Back to Blue campaign utilizes TV

advertisements for first time since 2009. 5% stock
appreciation.

INVESTMENT
PROPOSITION

Gap is positioned for double-digit revenue growth

Brand ethos, product diversification and global footprint drive Gaps success
Solutions

Decrease in mall traffic (15% decrease

since 2001)1

Even though Gap has 80% of its physical stores in malls, they are slowly
reducing their store footprint while increasing the benefits available in a store

Slow response to the Gap new image and

campaign initiatives

Although it may take some time for Gap to reach its pre-2000 popularity
levels, emerging Athleta and high international demand will continue to
support

Competition catching up with Gaps

leading omni-channel retail presence

With the new CEO, Gap is well equipped for innovation and has already
begun campaigns to tackle the issue

Additional Catalysts
Gaps strategy: Complete Global Omni-Channel Presence
New stores in areas with online only consumption:
40 in India to cater to high demand for US products | 110
total by end of 2014 in Eastern Asia where Gaps family
oriented collections thrive | First Old Navy to open in Middle
East in 2015
Removing Stores in heavily concentrated areas:
Removing 6 million sq feet in North America to improve ROA

Global Expansion

COMPANY OUTLOOK

Potential Risks

vs.

Athleta: fastest growing brand

79 stores opened since 2009;

competes with Lulu Lemons 263

According to Google Trends, Athleta

search queries have increased 17%
YOY and LULU has decreased 8%

LULUs shares have fallen 50% in last

year

Projected Timeline of Key Events

Close of 2014: Gap closes out with 110 stores in
Eastern Asia

FY15 Q1 Earnings will indicate whether new Gap initiatives were

successful at capturing 4% expected increase in holiday spending2

Feb 1, 2015: Art Peck takes office as CEO

11

1.
2.

Ready to Play Offense, J.P Morgan Report

Deloitte Analysis

INVESTMENT
PROPOSITION

Strategic Analysis

COMPETITIVE LANDSCAPE

Gap has the most advanced omni-channel capabilities of its peer group and the strongest managerial
incentives for shareholder-friendly behavior

Global
Footprint

Active Stores

3539

1132

1025

551

3219

603

Franchises

375

66

170

Supply Chain

Diversified blend
of manufacturers
and retailers; 28%
from China
manufacturers

Diversified blend
of manufacturers
and retailers;
concentrated in
China / Japan

Diversified blend
of manufacturers
and retailers;
concentrated in
Southeast Asia

Vendor based;
data analysis to
optimize
inventory levels

Diversified blend;
primarily
manufacturers;
no special
treatment

Outsource all
production;
Source products
and raw
materials

Ship From Store

Reserve In Store
Order In Store

Fulfill online
orders at stores
through Buy
Online Ship from
Store

Integrate in-store
and online
operations;
Manage as a
single channel

Upgraded
zumiez.com;
expanded
access to
inventory in all
channels

[ no data ]

Utilize OC to
deliver a
seamless and
integrated
shopping
experience

Performance
Shares up to
450% of salary;
175% salary
bonus

$2.5mm
forfeitable RSU;
130% salary
bonus

66,666
Performance
Shares available
annually;
75% salary bonus

58% salary bonus

300,000
Performance
Shares annually

[ no data ]

OmniChannel

Management
Incentives

12

1. Gap Inc. has Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, Italy, China, Hong Kong,
and beginning in March 2014, Taiwan. They also have franchise agreements with unaffiliated franchisees to operate Gap, Banana Republic,
and Old Navy stores throughout Asia, Australia, Eastern Europe, Latin America, the Middle East, and Africa.

INVESTMENT
PROPOSITION

Store Profitability

COMPETITIVE LANDSCAPE

Gap produces revenue / store roughly inline with peer group, and expands profit margins while peers see
stagnation or contraction

Global
Footprint

Revenue

16,306

3,256

2,520

758

28,199

7,584

OpEx

14,213

3082

2363

683

24,768

6,842

Rev / Store
(2009 2013)

OpEx / Store
(2009 2013)

13

4.7

3.4

4.5

3.2

4.3

4.1

2.8

3.9
3.7

2.6
2.4

1.4
1.3

2.2

1.2

2.6

1.1

2.4

1.8

4.7

3.4

2.6

1.4

4.5

3.2

4.3

4.1

2.8

3.9

2.6

3.7

2.4

2.4

1.3

2.2

1.2

1.1

1.8

1. All values, include axis ticks, are USD in millions

2. Revenue and OpEx utilize LTM data from 2 August, 2014. Source: Capital IQ

20

8.5

18

16

7.5

14

12

6.5

10

20

8.5

18

16

7.5

14

12

6.5

10

INVESTMENT
PROPOSITION

Financial Benchmarking

FINANCIAL VALUATION

Gap generates industry leading margins and returns, but still trades meaningfully below its peers on a
multiples basis

Global
Footprint

Dividend Yield

2%

4%

0%

0%

1%

1%

Gross Margin

46%

34%

53%

36%

28%

58%

EBITDA Margin

16%

9%

11%

14%

14%

18%

EV / EBITDA
(2015E)

6.3x

6.7x

6.3x

9.4x

10.3x

10.1x

Return on
Assets

17%

6%

10%

10%

21%

11%

Return on
Capital

29%

9%

23%

15%

39%

14%

1. All metrics utilize LTM data from 2 August, 2014. Source: Capital IQ

14

INVESTMENT
PROPOSITION

Fundamental Analysis

Gaps underlying businesses are worth at least 25% more than the value implied by its current stock price
50.00
45.00
40.00
35.00
30.00

FINANCIAL VALUATION

25.00
20.00
15.00

Revenue Assumptions

Expense Assumptions

North America 83% of revenue,

mature market, base growth of 2%
+- 0.5%

COGS Assume 0.15% +-0.05%

margin expansion due to supply
chain reforms and inventory
streamlining

Asia 10% of revenue, untapped

market, base growth 15 - 20% +- 5%

SG&A Leverage increases 0.1%

annually, as advertising efforts in
new markets decrease, but
competition restricts further savings

Rest of World 7% of revenue,

mixed market composition, no
insight, assume terminal growth
rate

Valuation Timeline
1 . Peck formulates a new strategy for Gap
2 . New stores are opened, retail channels shift; Bay finds her stride
3 . International markets grow revenue; margins stabilize
1 . Preparation

Base Case Target: $48 (+27%)

Drivers: Omni-Channel Conversion,
International Expansion

Bull Case Target: $50 (+30%)

Drivers: International Expansion, Supply
Chain Efficiencies

Bear Case Target: $39 (+2%)

Drivers: Product Appeal, International
Expansion

Other Assumptions
Geographic Variation Assume
none; profit margins may differ in
different areas of world
Franchise Growth No sensitivity;
may expand in MENA profit margin
Rest of World Assume
homogenous; may have local
factors affecting growth / profit

Catalyst Events
1 / Q3 2014 Earning Call | 21 November 2014
2 / Investor Day 2015 | April 2015

2 . Implementation
3 . Capitalization

3 / Q1 2015 Earnings Call | May 2015

Today

15

Month 12

24 Month Horizon