Why Gap Will Never Be Great Again

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Gap StoreGap (GPS) investors should be pretty stoked right now.

Shares of the company behind Old Navy, Banana Republic, and its namesake apparel chain have been on fire this year. Gap's stock has climbed higher in five of the past six months, notching an impressive 47.5% gain through the first half of 2012.

It's easy to fall into the trap -- a Gap trap, if you will -- of thinking that the former Wall Street darling is back. Gap was a big retail winner through the 1980s and 1990s, but things haven't been as encouraging on this side of the millennium.

A Generation Gap

The chain that seemed it could do no wrong as it outfitted trendy shoppers with denim and khakis throughout the '90s has grown stale in recent years.

The emergence of Target's (TGT) cheap-chic allure for basics and discounters Kohl's (KSS) and TJX (TJX) loading up on more stylized apparel at compelling values have slammed Gap over the past decade. The past few months of gains must feel good to investors, but long-term shareholders know better. The stock is still trading lower than it was a dozen years ago.

Then again, today's investors should neither bask in the '90s nor lament the past decade. We're living in the here and now, and surely Gap's registers must be going crazy if the stock's been on fire this year.

Unfortunately, that's just not the case.


Leaving So June?

Gap announced its sales results for the month of June this morning. Comparable-store sales clocked in flat. In other words, the average store sold just as much last month as it did in June 2011. If we compare last month to June 2010, comps have inched a mere 1% higher over two years.

Think about that. The economy's had a chance to recover, but Gap couldn't even keep up with inflation!

Now, there's a bullish counter to that slam. The culprit this past month is a stifling 14% plunge in international comps. Gap's three marquee brands are at least moving in the right direction closer to home.

Let's look at the comps for individual brands for June in North America:
  • Gap: 4%
  • Banana Republic: 5%
  • Old Navy: 1%
That doesn't seem too shabby -- even if North American comps for the Gap brand were actually negative in June of the prior year -- but it doesn't justify the big run-up that the stock has experienced this year.

It's All About Value

Gap may not seem outrageously priced at 14 times this fiscal year's earnings forecast and a mere 13 times next year's profit target. Investors are also enjoying a reasonable 1.8% dividend yield.

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However, where's the growth to justify that kind of multiple? Analysts see revenue growth slowing to a mere 2.7% next year, and that's largely on the wishful assumption that international sales will stabilize.

Let's put that kind of multiple into its proper perspective. If you think that Gap at 13 times next year's earnings is a bargain, what do you make of Apple (AAPL) at only 11 times next fiscal year's bottom-line target? Apple's actually growing, with analysts seeing top-line growth of 49% this year and 21% come fiscal 2013.

In other words, Gap isn't cheap -- and that's before one begins to wonder about where it goes from here.

After all, Gap may have stood out during the designer denim craze of the '80s and the khakis revolution of the '90s, but now everybody's pretty much selling the same stuff. The reason Gap has meandered through this lost decade is that differentiation is toast with its marquee brand, and discounters are all over the Old Navy value-pricing approach.

Retail is fickle. Shoppers move on. It's time for Gap investors to do the same.

Why Gap Will Never Be Great Again

(HGG)
At a time when Best Buy (BBY) is closing stores and looking for a new CEO, rival hhgregg is thriving.

The consumer electronics retailer saw net sales climb 21% in its latest quarter, and it's planning to add 20 to 22 new stores in its fiscal year that began in April.

Why is the awkwardly named hhgregg growing at a time when Best Buy is shrinking? Well, hhgregg emphasizes heavy appliances and mattresses, which are among the many items that may be too big to effectively sell online. Can you imagine the shipping charges on a washer/dryer combo? It also helps that hhgregg doesn't rely on regular traffic from folks picking up the latest CDs or DVDs, as digital delivery of music and video is also clobbering Best Buy.

(TGT)
The cheap-chic discounter is tackling the showrooming trend head-on. Earlier this year, the company revealed that its plan to keep Amazon.com (AMZN) at bay involves a steady diet of exclusive products.

Target routinely teams up with trendy designers for product lines that can only be purchased at Target. If vendors can't provide the chain with Target-exclusive products, the company is asking for pricing discounts so it can match online-only rivals.

It's not a perfect strategy, but Target also has a level of panache that's lacking at its rival discount department stores. People gab about going to Target -- or "Tar-zhay" -- on Twitter or Facebook. You'll probably never see anyone bragging about heading out to Kmart.

(COST)
Warehouse clubs are used to cutting costs to the bone. The exposed beams, stacked racks, and frills-free decor aren't an intricate theme. The warehouse setting is deliberately bare-boned to pass the savings on to end users.

It also doesn't hurt that items are being purchased in bulk for deep savings. And, naturally, the perishable nature of many of its items also makes them a natural choice for in-store, rather than online, purchases.

How popular is Costco? Well, it pushed through a 10% increase in its monthly membership fee -- yes, Costco shoppers have to pay for the right to shop there -- and customers didn't flinch at all.

(CONN)
Another Best Buy rival that's showing no signs of online stores nibbling at its market share is Conn's. The company's latest quarter saw comparable-store sales soar 17.8%. As Best Buy copes with shrinking margins, Conn's gross margins expanded to the point that it was able to deliver quarterly operating profits and net income that more than doubled over the prior year's performance.

Part of Conn's recipe for success is an emphasis on the appliances and mattresses that have been keeping hhgregg immune from the deadly dot-coms, but Conn's also goes even further by offering full furniture lines.

Conn's 64 stores are also in the farming heartland of Texas, Louisiana, and Oklahoma -- places where the prevalence of homes on large tracts of land benefit its sales of lawn tractors and zero-turn mowers.

(KMX)
CarMax is the country's largest retailer of used cars. Its 112 used-car superstores offer haggle-free pricing, and they'll buy your used car even if you don't buy one. Why not? The company's gross profit on used cars is three times greater than the gross profit on new vehicles.

Being a category killer has its advantages. Even the success of eBay (EBAY) with its eBay Motors ultimately can't compete with CarMax's regional presence in 56 markets.

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Longtime Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple and creating a bull call spread position in Apple.

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