Why Gap Shares Are Cheap Ahead of Third-Quarter Earnings

Gap shares have declined sharply this year, but investors may want to consider this undervalued stock.
By Richard Saintvilus ,

Owing to weak consumer spending, the retail sector continue to get crushed, sending the SPDR S&P Retail ETF (XRT) - Get Report down more than 11% in 2015. And within that group, apparel store chain the Gap (GPS) - Get Report , whose shares have plummeted some 40% in 2015, has been one of the hardest retailers hit. So, investors who are looking for an undervalued stock may want to consider Gap as a long-term play.

Gap, headquartered in San Francisco, will report fiscal third-quarter earnings after the closing bell Thursday. For the quarter that ended in October, the average analyst earning-per-share estimate calls for 66 cents a share on revenue of $3.93 billion, translating to year-over-year declines of 25% and 1%, respectively. For the full year, ending in January 2016, earnings are projected to fall 9% year-over-year to $2.57 a share, while revenue of $16.16 billion would mark a year-over-year decline of almost 2%.

Sure, Gap shares are down some than 35% in 12 months, and the tepid revenue and earnings projections have hurt investors' confidence. But at around $25 a share, GPS stock trades at just 10 times fiscal 2016 earnings-per-share estimates of $2.74. That's seven points lower than what the average S&P 500 stock trades for. Apply a forward P/E of 17 to GPS shares and that translates to valuation of around $46, which is some 75% higher than where the stock trades today.

Expecting 75% gains in Gap shares in 12 months is unrealistic, yes. But despite its consensus hold rating, analysts on average expects these shares to reach $28, delivering more than 10% gains during that span. You may want to also consider Gap's 23-cent quarterly dividend that yields 3.65% annually. Not only is that yield about 1.65 percentage points higher than the average payer in the S&P 500 (SPX) index, the company has raised its dividend almost 200% in the past five years.

What's more, with consensus fiscal 2017 earnings estimates calling for $2.79 a share -- above 2016 estimates of $2.74 -- Gap is expected to return to earnings growth much sooner than expected. Aside from lessening the risk, Gap stock projects value, especially when combined with its strong dividend.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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