The stock's jumped nearly 80% in two months, and this week, two analysts upgraded the struggling retailer's shares while another reiterated his buy rating, suggesting that Gap is finally righting itself. But the company's believers have been fooled before, and a number of observers say the company's short-term success may be drawing attention away from long-term problems such as high costs, competition from discounters and weak branding.
"I think people are a little too excited about this turnaround right now," said Jeff Matthews, general partner of Greenwich, Conn.-based investment firm Ram Partners, and a
contributor. "They have a long way to go before they're
Until last month, Gap had been in a free fall for more than two years, posting 29 straight months of declining same-store sales. The San Francisco-based company finally broke the losing streak when it posted same-store sales gains within each of its four primary divisions in October. For an encore, it is expected on Thursday to post positive same-store sales figures for November.
Some see this as evidence that the company's efforts to right itself are finally paying off. Earlier this year, the Gap replaced chief executive Mickey Drexler, who presided over the company's huge growth in the mid- to late-1990s, with Paul Pressler, a longtime Disney executive. Under Pressler, the company has attempted to better differentiate its Old Navy, Gap and Banana Republic brands.
The company, which nearly doubled its store space in recent years, also has promised to close some of its stores and cut the total square footage it operates by 2%. And it has attempted to keep its capital expenditures in check.
A recent advertising campaign helped push sales at Old Navy in October, wrote UBS Warburg analyst Richard Jaffe in a research note on Tuesday. A similar holiday ad blitz likely will help the company's sales in November and December, Jaffe said.
"We believe Gap has the means to further accelerate its improvement in performance," Jaffe said in his note.
Over the Thanksgiving weekend, Wedbush Morgan Securities analysts performed their annual "Mall Crawl," observing holiday spending at retail stores around the nation. Wedbush Morgan analyst Adrienne Tennant said the firm was encouraged by what it saw in Gap stores. The stores had good amounts of foot traffic and had all of their cash registers running, she said.
"We're positive on them," said Tennant, who has Gap shares. Wedbush Morgan upgraded Gap to buy last month.
The positive buzz around the company helped send its shares up early Tuesday. However, Gap followed the market down in the afternoon, closing off 24 cents, or 1.5%, to $15.75. Since bottoming at $8.84 on Oct. 7, Gap shares have risen nearly 78%.
Tennant's upbeat assessment of the Gap followed that of Gerard Klauer Mattison's John Morris, who
upgraded the stock from neutral to buy on Monday. Morris said apparel sales have started off stronger than expected, and Gap in particular has been able to win customers by improving the style and quality of its clothes.
The company's shares may do well in the short term, especially following its November same-store sales numbers, SG Cowen analyst Lauren Cooks Levitan wrote in a research note on Tuesday (she upgraded Gap shares to market outperform from market perform; her firm intends to seek investment banking business from the Gap). But Levitan said that the company still has long-term concerns.
The same-store numbers are helped by the fact that the company performed so poorly last year, when the same-store figures fell by 25% in November, she wrote. The company also faces increased competition from mass merchants such as
and is still having trouble differentiating its brands, she said.
For discounters such as Target and
, apparel represents an attractive opportunity, because the gross profit margins are higher than on their other goods, Levitan said. Gap's profit margins -- its net revenue minus the cost of its goods -- were more than 35% last year. Wal-Mart's profit margins, by comparison, were just 21%.
Because the margins are significantly higher, the discounters can afford to compete with Gap on price while still seeing good returns, Levitan said.
"We still believe
Gap will need to target a more defined customer and thus we retain our longer-term concerns about its ability to navigate through a more competitive, mass merchant-dominated retail environment," Levitan said. SG Cowen holds a stake in Gap.
Several analysts feel the company overexpanded during its salad days in the late 1990s and has not done enough to cut back.
Moody's Investor Service
, for instance, has rated Gap's debt at below investment grade and has maintained a negative outlook on the company.
The Gap spent $4 billion from 1999 through 2001 renovating stores and increasing retail space by 93%.
In contrast, through the first six months of this fiscal year, the company spent $163 million on capital expenditures, expanding store space by about 3%.
"We think the store base expanded too quickly, too much," said Elaine Francolino, vice president and senior credit officer at Moody's. "It remains to be seen what the company's longer-term plans are in terms of its store base."
Instead of cutting just 2% of it square footage, Gap may need to bump up its store closures to 5% to 6% of its square footage, said Rob Wilson, principal of Tiburon Research Group in San Francisco. But Wilson likes that the company is starting to talk about scaling back, and projects that it should have more than $1.6 billion in earnings before interest, taxes, depreciation and amortization this year, compared with a net loss of $7.8 million, or 1 cent per share, for its 2002 fiscal year, which ended Feb. 2.
"It's not as dire as a lot of people think it is, in my mind," Wilson said. "But there's still a lot of issues this company needs to face."