Having mention Gap (GPS) as a possible investment in a previous post , we must revisit the most recent conference call to see if any of the goals we set for it are being met.
Gap earnings call highlights (at least the ones that matter to me)
-2006 Earnings down and 2007 does not look much better- No surprise
-Closing Forth & Towne. Given the sales, productivity levels, and the traffic momentum we had seen to date, they felt that the probability of achieving an acceptable return on investment from a full rollout of the brand was too low. As a result, they will close 19 Forth & Towne stores by the end of June, 2007.
- Converting Old Navy outlet stores to Old Navy stores. Given the change in competitive environment, there is no longer a clear distinction between the two businesses. They expect to convert the 45 outlet stores by October of this year. This decision has no impact on Gap Outlet and Banana Republic factory stores.
- In addition to gaining cost efficiencies in management structure, this decision also allows them to close one of our Northern Kentucky distribution centers. The expenses associated with converting the Old Navy outlet stores and closing the distribution center will be about $6 million in 2007. However, annual savings from these measures are estimated to be $12 million.
- Regarding share repurchases, they plan to continue to use excess cash to opportunistically repurchase shares. At the end of the fourth quarter, they still had $200 million available under the current authorization. Gap has plenty of cash and still generates enough to buy much more back. My guess is that it will be left for the new CEO to announce the new amount to get him (her) off to a good start with shareholders.
- The real estate strategy for 2007. At this time, they expect to open about 230 new stores and to close about 200. The openings are weighted towards Old Navy as they continue to believe there is additional real estate opportunity and the returns remain attractive, and the closures are weighted to Gap and include the impact of the 19 Forth & Towne store closures. Please also note the 45 Old Navy outlet conversions will be recorded as both a closure and opening to reflect the reassignment. Full year net square footage is expected to be up about 1%.
Gap is off to a decent albeit anemic start. The Forth & Towne closing was a no brainer because it should have never been attempted in the first place. As for the other closings, there will be net gain of 49 stores at year end, mostly Old Navy. Of the 135 stores to close, most will be Gap. Here is my issue, they are only scratching the surface here. Gap does not need to get bigger, it needs to get more profitable and when you are not performing well given the present scale of your company, what make you think being bigger will magically fix that? In 2006, Banana Republic sales were up 14%. Old Navy's were flat and Gap was down 6%, so we aren't in a situation where the whole company is struggling, just Gap brands. The move to convert a few of them to Old Navy stores again is a good one but still not enough. What was not discussed was Banana Republic, why not convert some Gap's into them? Currently Gap is a retailer with an excellent premium brand (Banana Republic), a good value brand (Old Navy) and a John Candy like bloated mid-level brand (Gap). I need somebody to come in a say "we need to be more profitable, not bigger" because the two are not always directly related.
The CEO search continues and I cannot even think about investing until I know the who's and what's of what they plan to do. If they are of the Julian Day of Radioshack (RSK) or Eddie Lampert of Sears Holdings, (SHLD ) mold then I will be racing to buy Gap shares (for more on Radioshack, visit Chad Brand's blog The Peridot Capitalist ). Can you imagine what somebody like them could do with the Gap? What do I mean? Sears Holdings shares are up over 1000% since Lampert took over almost 3 years ago when both Sears and Kmart were left for dead by everybody. Radioshack has gone from one foot in the grave to seeing its shares up almost 80% since Day took over last summer. How did they do it? They have this novel approach that the most important thing they can do is grow profits, not just sell merchandise. Somewhere along the way, retailers got the "bigger at all cost is better" mantra ingrained in them and began to chase sales over profits. Lampert and Day have said, profits matter most, not just sales. This has lead them to close under performing locations, sell off unnecessary assets, keep closer tabs on inventory and not just discount merchandise to drive unprofitable revenue growth. They then take this extra money and begin massive share buybacks, pay off debt and to re-invest in the current locations that are performing satisfactorily. The potential here for a CEO like this to make shareholders very wealthy is just waiting to be had as Gap has $2 billion in the bank, produces another $1.5 billion of operating cash flow per year and is virtually debt free. If they would stop investing in trying to just get bigger and got smart, they could return a ton to investors via buybacks (I estimate 15%-20% in year one at current prices). Currently Gap (GPS) shares are trading over 10% below their early year buyout rumor highs.
If they new guy (gal) has more store growth aspirations or a "new product mix" goal, I will be watching from the sidelines. Gap has a lot to like about it and I think there is a ton of hidden value there, it just remains to be seen what the new CEO will do with it. Think of it this way, if both you and Emeril Lagasse have the same ingredients in your kitchens, my guess is his final results cooking dinner with them will be far superior. Thus is the dilemma with a CEO-less Gap, are we going to get Emeril or Norm Peterson's dinner from the "Hungry Heifer"? Please don't tell me you do not know who he is.......