“We can say without reservation that, in investing, spinoffs are the closest thing you can find to a sure thing. It all comes down to the incentives when companies spin off a subsidiary or division and hand out shares to their shareholders. Study after study has shown that after an initial adjustment period of a few months, spinoffs tend to outperform groups of comparable stocks for several years….” Pat McKeough shows how spinoffs and other “special situations” can create windfalls for informed investors.
GAP INC. $18(New York symbol GPS; Consumer sector; Shares outstanding: 378.0 million; Market cap: $6.8 billion; Dividend yield: 5.4%; Takeover Target Rating: Medium; www.gap.com) is a multi-brand apparel retailer based in San Francisco. It operates 3,335 stores under the following banners: The Gap (1,234), Old Navy (1,160 stores), Banana Republic (600), Athleta (165), Janie and Jack North America (140), and Intermix (36). Franchisees operate a further 514 stores.
Gap’s sales fell 5.6%, from $16.4 billion in 2015 to $15.5 billion in 2017 (fiscal years end January 31). That’s mainly because the company closed its 53 Old Navy stores in Japan as part of a plan to focus on its more-profitable North American businesses. Gap’s sales then rebounded 2.2% to $15.9 billion in 2018, before then rising a further 4.6% to $16.6 billion in 2019.
The company’s earnings, before store-closure costs and other unusual items, fell 35.0%, from $1.24 billion in fiscal 2015 to $807 million in 2017. Due to fewer shares outstanding, earnings per share declined at a slower rate of 28.6%, from $2.83 to $2.02. Earnings then rose to $2.13 a share (or a total of $842 million) in 2018, and improved again to $2.59 a share (or $1.0 billion) in 2019.
Overall earnings in fiscal 2019 benefited from much better inventory controls; the prior-year period included significant discounting to sell excess merchandise. Gap also eliminated a lot of its low-profit, or money-losing, items.
The company now plans to set up its Old Navy chain, which supplies around half of its overall sales, as a separate firm. Its remaining brands will stay with Gap. The company now expects to complete the spinoff sometime in early 2020.
Apart from the Old Navy spinoff, Gap also plans to close about 230 Gap stores over the next two years. It hopes that will help to create a better overall mix of Gap, outlet and online channels. The company also aims to draw nearly 40% of its sales from online channels, with the remainder split fairly evenly between its regular stores and its outlet channels.
In its fiscal 2020 first quarter, ended May 4, 2019, the company’s sales fell 2.0%, to $3.71 billion from $3.78 billion a year earlier. Overall same-store sales fell 4% due to declines at all of its major banners: Gap (down 10%), Banana Republic (down 3%) and Old Navy (down 1%).
The company blamed the lower sales on colder-than-normal spring weather, which hurt its customer traffic and sales of spring-related clothing. As well, the new U.S. tax reforms caused the IRS to withhold less income tax in 2018. As a result, most workers received lower income tax refunds in 2019.
However, thanks to a $191 million gain on the sale of a building, earnings in the quarter jumped 38.4%, to $227 million from $164 million. Gap repurchased $50 million of its shares during the quarter. As a result, earnings per share rose 42.9%, to $0.60 from $0.42. However, if you exclude all unusual items, it earned just $0.24 a share in the latest quarter.
As of May 4, 2019, the company held cash of $1.2 billion. Its long-term debt of $1.25 billion is a moderate 18% of its market cap.
Despite the slowing sales, Gap still plans to open 70 new stores (net of closures) in fiscal 2020. Even so, the company expects to earn $2.05 to $2.14 a share in 2020. That’s down from its earlier forecast of $2.11 to $2.26 a share. The stock trades at just 8.6 times the midpoint of its new range. The $0.97 dividend yields a high 5.4%.
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