The Gap: Rated Buy As I Expect Growth And Margins To Normalize

Investment Overview - The Gap, Inc. is expected to sustain growth momentum, potentially returning to low-single-digit growth in FY25, alongside an expanding adjusted earnings margin, which should lead to an upside reversion in valuation multiples [2] Business Description - GAP operates in the apparel retail sector with key brands including Old Navy, Gap, Banana Republic, and Athleta, focusing on North America and Asia, with 2,372 stores in North America and 169 in Asia as of 2Q24 [3] - Revenue distribution for FY23 is as follows: Gap Brand (22.4%), Banana Republic (13%), Old Navy (55.1%), and Other (9.4%) [3] 2Q24 Earnings - Total sales reached $3.72 billion, reflecting a growth rate of 4.8%, supported by a 3% comparable sales growth [CSG] [4] - Sales breakdown includes $2.48 billion from store sales and $1.24 billion from online sales, with brand revenues of $766 million for GAP, $479 million for Banana Republic, $2.12 billion for Old Navy, and $352 million for others [4] - Gross margin was 42.6%, with SG&A expenses at 34.7% of sales, resulting in an EBIT margin of 7.9% and an EPS of $0.54, surpassing consensus estimates of $0.41 [4] Solid Execution and Demand Traction - The performance in 2Q24 indicates potential for growth to accelerate back to low-single digits in the coming years, with a notable 3% CSG growth [5] - CSG showed improvement throughout the quarter, with positive year-over-year growth observed in August [5] Brand Performance - Old Navy was a key driver of CSG, achieving 5% growth, an acceleration of 200 basis points compared to 1Q24, benefiting from current consumer value consciousness [6] - The Gap Brand has shown consistent share gains, with 5 consecutive quarters of growth, while Athleta's CSG decline is attributed to prior discounting, indicating underlying demand remains stable [7] 3Q24 Guidance - Management's guidance for 3Q24 indicates slight sales growth compared to 3Q23, which may be conservative, as it suggests a significant decline from 2Q24 growth [8] - Factors influencing this guidance include macroeconomic conditions, credit card revenue expectations, uncertainty around Athleta's recovery, and tougher CSG comparisons [8] Valuation - Revenue is projected to grow by 1% in FY24 and 3% in FY25, with adjusted earnings margin expected to expand as topline growth recovers [12] - The forward PE multiple has decreased from approximately 17x to 10x, aligning with peers, and a potential upward re-rating is anticipated as growth and margins normalize [12] Conclusion - The company is positioned for a turnaround, with expectations of low-single-digit growth driven by strong execution from management and favorable consumer preferences, likely resulting in positive market reactions as growth and margin normalization signs emerge [14]