Investors still don't appreciate Gap's turnaround - but retailer's room for error is shrinking, analysts say

By Bill Peters

'We believe [Gap] is in the early innings of transformation across all four brands, and the earnings growth potential is underappreciated,' TD Cowen analysts say

Gap Inc. stands to gain from the back-to-school season, increasing relevance at its namesake stores, a product refresh at its Old Navy stores and early signs of improvement at its fitness brand Athleta, TD Cowen analysts said Tuesday.

But Wall Street, they noted, has yet to get the message.

The analysts upgraded shares of the clothing retailer to buy from hold, and raised their price target on the stock to $30 from $28. Shares of Gap (GPS) dipped 0.3% on Tuesday, but the stock has risen sharply this year.

"We believe [Gap] is in the early innings of transformation across all four brands, and the earnings growth potential is underappreciated," the TD Cowen analysts wrote.

They said Gap had kept inventories tight and exercised restraint on running aggressive sales and markdowns, moves that would help profit margins.

Citing data from Prosper, the analysts said that around 85% of shoppers either planned to spend more on back-to-school gear this year or keep those spending levels the same as last year. That figure compared with around 83% in 2023.

At Gap's namesake stores, the analysts said, new products and a livelier marketing push have led to two quarters of positive same-store sales. And they said consumer interest in buying jeans at the Gap had crept higher as looser fits replace skinny jeans in shoppers' wardrobes. They added that Old Navy's newer merchandise was catching on with consumers, and that "newness" should help Athleta as well. Gap bought Athleta in 2008.

Shares of Gap rallied in May after the retailer boosted its outlook. Afterward, Jefferies analysts said Gap was in the "early innings of a turnaround."

Company executives in May called out strength in Old Navy's women's clothing and activewear, and said they were pushing spring colors and linens, and testing out new merchandising strategies and store-layout ideas. Gap in February announced it had made fashion designer Zac Posen its new creative director and Old Navy's chief creative officer.

The clothing industry is rolling out new products in an effort to attract consumers, as it races to regain relevance after pandemic-related supply disruptions and inflation left stores with clothes people didn't want.

However, shares of Gap are up 18% so far this year and have climbed nearly 177% over the past year. Given those massive gains, the TD Cowen analysts on Tuesday suggested the room for error was narrow.

"The recent stock run suggests elevated expectations, and any miss on earnings or signs of deceleration in growth will likely lead to multiple contraction," they said.

-Bill Peters

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

06-25-24 2255ET

Copyright (c) 2024 Dow Jones & Company, Inc.