Gap's Story Still Has Holes

The Bottom Line

I don't believe you can own Gap here. Taking a look at the top 23 ($1 billion-plus market-cap) apparel retailers, Gap trades in line on a price-to-earnings ratio and a forward P/E basis to its peers. However, its projected long-term growth rate of 11.14% (not including any analyst revisions over the past 24 hours) badly lags the average 17.05%. Gap's 1.89 price-earnings-to-growth, or PEG, is very rich compared to the average 1.3 times growth.

In order for its shares to become interesting, Gap needs to offer either a growth or value story. Right now, growth is out of the question, as the company stated that 2007 earnings will be lower than last year. At some point, Gap may become a growth story again, but for now we have to wait until it becomes a better value.

I don't believe Gap becomes a value play until it's trading at least in line with its peers on a PEG basis, which brings the stock down to about $14.50, and maybe even lower. Perhaps over the next year, a catalyst changes that formula. But until there's a reason to be excited about Gap's prospects, there's no reason to pay a premium. In fact, like its decreasing number of customers, you should demand a markdown.

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