Shares of The Gap Inc. (GPS) on Friday experienced their biggest daily gain in months following the clothing retailer’s huge announcement regarding its corporate structure moving forward. The news overshadowed the firm’s mixed Q4 earnings report, which beat on the bottom line but slightly whiffed on the top line.
The Gap – which owns its namesake chain, Banana Republic, Old Navy, Athleta, Hill City, and Intermix – traded near year-to-date lows the entire month of February, making today’s news a welcome relief for investors still skeptical of the retail sector’s health. But most investors don’t realize just how much The Gap’s announcement late Thursday night could ultimately boost not just the GPS stock price but also the value of other retail companies in the long run.
Here’s a closer look at the news driving GPS shares today – and how the firm’s decision could influence other major retail players in 2019…
The News
On Thursday, Feb. 28, The Gap announced plans to split its business into two separate publicly traded retail companies. One firm will manage the Old Navy brand and retail locations that rake in about $8 billion in annual sales, while the other unnamed firm – tentatively dubbed “NewCo” – will be comprised of all the other brands like Banana Republic and Hill City expected to bring in roughly $9 billion in annual sales.
While the Gap brand itself struggles to healthily grow sales, Old Navy is more successful thanks to its successfully strategy of targeting budget-oriented shoppers. Global sales of Gap-branded products declined by 5% last year as sales of Old Navy-branded items climbed 3% over the same period. Gap’s lackluster sales have urged the parent company shutter 230 Gap brand “specialty” retail locations through 2021 as part of the broader plan to peel away the firm’s weaker brands.
Analysts embraced the decision, calling it a significant step toward making each brand leaner and more strategically focused. Randal Konik of Jefferies Financial Group Inc. (JEF) said the separation of Old Navy from The Gap’s weaker brands will “allow the market to properly value Old Navy for its high margins and strong cash flows.”
The Gap’s board chairman Robert Fisher shared similar sentiments, arguing that splitting into two separate firms will allow for more brand-oriented strategies due to the fact that “Old Navy’s business model and customers have increasingly diverged from our specialty brands over time.”
The spin-off announcement arrived right on the heels of a mixed Q4 earnings report. The company posted a profit of $0.72 per share, crushing the $0.62 estimate by more than 16% and increasing 38.5% from the $0.52 reported for the year-ago period. Revenue, however, was the sore spot, falling 3.8% from $4.8 billion in Q4 2017 to $4.62 billion in Q4 2018. Last quarter’s revenue also missed analysts’ forecasted $4.69 billion by 1.5%.
How Investors Reacted
Investors and analysts alike applauded the spin-off, sending the stock 16.2% higher on Friday to close at $29.51 per share. That’s The Gap’s highest settlement since Sept. 5, 2018 when shares traded hands at $30.26.
Friday’s rally added to an already enormous run for GPS stock in 2019. Shares are up more than 14% year-to-date from $25.76 on Dec. 31 to $29.51 on March 1.
The Bigger Picture
One of the most prominent certainties rocking the economy in recent years is the slow death of the retail sector, grimly nicknamed the “retail apocalypse.” As Amazon.com Inc. (AMZN) grabs a larger and larger percentage of U.S. retail sales, brick-and-mortar stores continue to close at a rapid pace, with the bankruptcies of Toys “R” Us and Sears Holding Corp. now emblematic of this trend.
But the dismal statistics don’t stop there. Closures of retail stores soared to record highs last fall as closures by square footage reached nearly 125 million back in August. That coincides with retail’s gradual shift to the Internet – about 10% of all retail spending in the U.S. occurs online as of late 2018.
Now, other retail companies feeling the pinch may opt to follow The Gap’s initiative since it would not only remove lackluster brands from the portfolio but also revitalize the brands raking in the most revenue. Dana Tesley, CEO of consumer-focused brokerage firm Telsey Advisory Group, said this comes from the retail sector’s broader “transformational change,” noting VF Corp. (VFC) as one of the first companies to start this trend by spinning off denim brands Wrangler and Lee last year.
It’s likely that more struggling retailers with vast brand portfolios will copy this strategy in the future. Abercrombie & Fitch Co. (ANF), Tesley states, could move to spin off its Hollister brand sometime this year. Competing firm American Eagle Outfitters (AEO) could do the same with Aerie, its lingerie business.
Looking Ahead
The death of an entire sector requires the companies in that sector to adapt quickly and affordably, which is why investors and analysts widely approved of The Gap’s spin-off decision on Friday. The move clearly indicates The Gap is constantly strategizing its business in order to avoid being swept up in the apocalypse that’s taken brick-and-mortar peers like Sears and Toys “R” Us.
Investors should always consider buying into any company planning to revitalize its business for the long term. With that in mind, GPS appears to be a strong investment to hold through the ups and downs of the retail sector’s seismic transformation.