A year ago, Gap (GAP -1.14%) stock was flying high, as government stimulus programs and fading COVID-19 restrictions ignited a boom in sales of discretionary goods. Unfortunately, the company's momentum didn't last. Supply chain problems caused Gap to miss its 2021 full-year guidance. The retailer's problems have mounted in 2022.
With Gap's post-pandemic turnaround plan in shambles, the company fired CEO Sonia Syngal this week. Meanwhile, Gap stock has tumbled into single-digit territory -- down more than 50% compared to three years ago and down 74% from its July 2021 peak.
Gap's results will probably remain weak in the near term. However, the company has a strong balance sheet and solid turnaround potential. That makes the stock's recent tumble a potential buying opportunity for risk-tolerant investors.
A turbulent tenure
Syngal was promoted to be Gap's CEO in March 2020 after four years running the company's top brand, Old Navy. She started in her new role just as U.S. discretionary retailers were temporarily closing their stores in response to the rapid spread of COVID-19.
During 2020, Syngal did an admirable job of steering Gap through the first months of the pandemic. She also laid out an ambitious strategy to return the company to growth and improve its profitability.
Apparel demand surged in 2021, giving Gap a huge boost. Halfway through the year, Gap projected that sales would jump roughly 30% year over year in fiscal 2021, leading to adjusted earnings per share (EPS) between $2.10 and $2.25, up from $1.97 in fiscal 2019. Instead, supply chain snarls and surging freight costs hurt sales and profitability. Gap ended the year with sales up 21% year over year -- and just 2% higher than fiscal 2019 -- and adjusted EPS of $1.44.
Despite the weak end to the year, Gap entered 2022 expecting modest sales growth and full-year adjusted EPS of $1.85 to $2.05. But in May, the company reported a big loss for the first quarter and slashed its guidance, due to execution missteps at Old Navy and the effect of inflation on discretionary spending. It said that revenue would decline in fiscal 2022, and adjusted EPS would fall to between $0.30 and $0.60.
Moreover, key aspects of Syngal's growth strategy have backfired. Old Navy's business is in shambles, partly due to a botched inclusive sizing campaign. With results still deteriorating, Gap finally decided it needed new leadership.
Image source: Gap, Inc.
Lots of problems to solve
In conjunction with announcing the leadership change, Gap said that aggressive efforts to sell excess inventory will have a greater-than-expected effect on gross margin this quarter. As a result, the company now anticipates that its second-quarter operating margin will be roughly zero or slightly negative. Gap didn't update its full-year outlook, but it seems likely to further reduce its earnings guidance when it officially reports its Q2 results.
Old Navy's new CEO, Haio Barbeito, faces the tough task of winning back customers just as they are cutting back on discretionary purchases due to inflation. Sales for Gap's biggest brand plummeted 19% in the first quarter, highlighting the extent of Old Navy's woes.
Meanwhile, the flagship Gap brand is still floundering. The brand rang up sales of just $497 million in the U.S. last quarter, down from $680 million just four years earlier.
Even the highly touted Athleta activewear brand has lost some of its luster. Sales inched up just 4% year over year last quarter, while comparable sales fell 7%. For comparison, top competitor Lululemon reported that sales surged 32% on a 28% comp sales increase over the same period.
Not a lost cause
Looking ahead, investors should prepare for a multiyear turnaround process at Gap. On the bright side, Gap ended last quarter with $845 million of cash and just $1.8 billion of debt. As it converts inventory to cash in the second quarter and beyond, Gap's balance sheet should improve further, giving the company plenty of time to implement a turnaround plan.
Despite its recent slump, Old Navy has a long track record of success. As its new management team fixes the brand's recent missteps and economic conditions improve, Old Navy should be able to reach its long-term goal of exceeding $10 billion in annual sales with a double-digit operating margin. That could make Old Navy alone worth at least twice as much as the entire company's current enterprise value of $4.2 billion.
Gap Enterprise Value, data by YCharts.
Athleta has plenty of potential over the long term, and the upscale Banana Republic brand is making a modest comeback in 2022. The value of those brands adds to Gap shareholders' long-term upside.
Thus, Gap stock could prove to be a bargain for patient investors who buy now. That said, it's a risky bet given that most of the company's divisions are struggling at the moment.
