Gap Earnings: Improving Profitability Provides Confidence in Turnaround; Shares Slightly Undervalued

Overcoming a tough North American apparel market, Gap reported solid second-quarter results. Since joining the company last year, CEO Richard Dickson has implemented changes in personnel, merchandising, marketing, and operations that have reinvigorated its brands. Most importantly, Old Navy, which accounted for 57% of the quarter’s sales and is the main driver of profits, has returned to comparable sales growth (5% in the period). We expect to lift our $26 fair value estimate by a low-single-digit percentage, leaving shares a bit undervalued. Although we rate Gap as a no-moat company, we think it has strengths, including the high awareness of its brands and their appeal to many demographic groups.