The Gap Fundamental Analysis

Matt's Fundamental Stock Analysis

Content Disclaimer: I am only a retail investor and I only intend these reports to be used as a guidance. I recommend you do your own research as this will better help you to understand how companies work and operate and what drives their growth. What stocks you decide to purchase, should be chosen by you and this report is made only to display companies which I think are worthwhile to look at and discuss. Just because it is a good company or I like the company does not mean that it will do good in the future. If you want to copy or replace my report, please do so with a link connecting to my blog.

Gap Inc. (GPS) Company Business Gap Inc. sells clothing, accessories and personal health care products under The Gap, Old Navy, Banana Republic, Piperlime, and Athleta brands. Items can be purchased either from inside the retail stores or through their online stores. It has company operated stores in Canada, United States, UK, France, Ireland, Japan, China and Italy. They also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in many countries worldwide. Also, in November 2011 they announced the launch of its store in Hong Kong. Management promotes that their competitive advantage is their ability to develop and evolve their existing brands and they believe it is key to their success. Additional Notes: Have a share repurchase program in place Highly seasonal business with high demand in back to school and Christmas shopping (second part of the year) Plan to open additional stores, many of which will be outlets in Canada, Europe, and Asia

Potential Risks North America stores have been seeing a decrease during 2010 while international markets (Europe and Asia) are seeing growth.

If Athleta becomes successful it can mean better things from Gap Inc. In fiscal 2011 Gap Inc expected to open 115 new Company-operated stores and close around 125 company-operated stores 75 new franchise stores are expected for fiscal 2011 Net sales increase for 2010 was primarily due to international markets Increase to $0.45 dividend paid per share is expected in fiscal 2011 They hedge their currency risk

Historical Ratio Analysis **If the value is green than the number is believed to be better than the previous number, vice versa if the value is
red

Profitability Ratios
ROE ROA ROIC CROIC

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

-0.3% -0.1% 6.1% 6.8%

2002

13.1% 4.8% 14.1% 13.0%

2003

21.5% 10.0% 23.9% 24.2%

2004

23.3% 11.4% 26.7% 15.1%

2005

20.5% 12.6% 25.4% 13.8%

2006

15.0% 9.1% 18.7% 10.8%

2007

19.5% 10.6% 24.3% 25.9%

2008

22.0% 12.8% 28.6% 18.1%

2009

22.5% 13.8% 31.0% 27.2%

2010

29.5% 17.0% 39.6% 23.9%

2011

Solvency Ratios
Quick Ratio Current Ratio Total Debt/Equity Ratio Long Term Debt/Equity Ratio Short Term Debt/Equity Ratio

0.67 1.48 1.52 0.65 0.01

1.35 2.11 1.71 0.79 0.14

2.00 2.68 1.16 0.52 0.06

2.00 2.81 1.04 0.38 0.00

1.82 2.70 0.63 0.09 0.00

1.42 2.21 0.65 0.04 0.06

1.03 1.68 0.83 0.01 0.03

1.16 1.86 0.72 0.00 0.01

1.50 2.19 0.63 0.00 0.00

1.10 1.87 0.73 0.22 0.00

Profitability ratios look to be all in favor while their debt is remaining around historical levels and their quick and current ratio are a bit blower historical average.

Efficiency Ratios
Asset Turnover Cash % of Revenue Receivables % of Revenue SG&A % of Revenue R&D % of Revenue

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

1.82 7.5% 0.0% 27.5% 0.0%

1.46 23.4% 0.0% 27.0% 0.0%

1.53 14.3% 6.8% 25.8% 0.0%

1.62 13.8% 0.0% 26.4% 0.0%

1.82 12.7% 0.0% 25.7% 0.0%

1.87 12.7% 0.0% 28.1% 0.0%

2.01 10.9% 0.0% 27.8% 0.0%

1.92 11.8% 0.0% 26.8% 0.0%

1.78 16.5% 0.0% 27.5% 0.0%

2.08 10.6% 1.4% 26.7% 0.0%

Liquidity Ratios
Receivables Turnover Days Sales Outstanding Days Payable Outstanding Inventory Turnover Average Age of Inventory (Days) Intangibles % of Book Value Inventory % of Revenue

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

0.00 0.0 45.4 5.30 68.83 12.8% 12.1%

0.00 0.0 48.3 4.70 77.60 10.5% 14.2%

1.92 24.7 46.6 4.92 74.25 6.0% 10.7%

2.14 0.0 48.8 5.27 69.29 0.0% 11.2%

0.00 0.0 43.4 5.43 67.22 0.0% 10.6%

0.00 0.0 41.5 5.59 65.27 0.0% 11.3%

0.00 0.0 38.6 5.65 64.60 0.0% 10.0%

0.00 0.0 41.8 5.52 66.07 0.0% 10.4%

0.00 0.0 47.5 5.30 68.91 3.3% 10.4%

11.75 5.1 46.6 5.30 68.82 3.8% 11.0%

Within the efficiency ratios, cash as a percentage of revenues is greatly below its historical averages. A closer look at the cash flow statement, reveals there decrease in cash was influenced heavily by their repurchase of common stock which amounted to $1,959 Million.

2008

2009

2010

2011

P/E P/S P/BV P/CF P/FCF

16.54 0.87 3.22 7.98 9.85

8.49 0.57 1.87 3.65 8.37

11.57 0.90 2.61 4.85 8.00

10.01 0.82 2.95 4.75 10.15

All five ratios consider the company to be fairly valued. My only concern is that P/FCF is higher than its previous 5 years.

Relative Ratio Comparison The Gap does not classify its direct competitors on their latest's annual statement. However, I believe there competitors to consist of Abercrombie & Fitch Co. (ANF), American Eagle Outfitters (AEO), and The TJX Companies (TJX).
ANF Stock Price Mkt Cap ($M) EV 52 Wk High 52 Wk Low % off 52Wk Low $ $ $ $ $ 45.35 3,900.00 3,380.00 78.25 40.25 12.7% 20.2 1.0 2.0 8.8 54.2 5.7 1.6% 1.3% 3.1% 30.6% 21.5% 1.0% 4.6% 2.1% 67.5% -15.6% 1.1 2.1 1.4 1.4 62.9% 65.8% 7.8% 13.5% 5.0% 8.6% 6.7% 11.4% 10.6% 17.9% 46.3 2.5 1.3 AEO $ 13.70 $ 2,650.00 $ 2,160.00 $ 16.37 $ 10.00 37.0% 14.3 0.9 2.0 8.1 0.0 5.1 3.2% 2.0% 19.0% 98.8% 10.7% 0.9% 5.0% 59.0% 13.7% -6.5% 1.6 3.0 0.0 0.0 37.4% 42.9% 9.4% 14.8% 6.2% 9.6% 9.8% 14.6% 13.5% 20.2% 74.5 3.9 1.6 TJX $ 34.52 $ 26,040.00 $ 25,720.00 $ 34.94 $ 23.92 44.3% 19.9 1.1 8.6 14.2 42.1 9.1 1.1% 1.3% 20.1% 20.4% 4.8% 1.1% 6.6% 14.9% 1.7% 18.5% 0.5 1.6 24.7 24.8 27.1% 25.2% 9.6% 8.4% 5.9% 5.2% 16.2% 15.2% 43.0% 42.2% 98.1 4.8 2.7 GPS $ 21.33 $ 10,420.00 $ 10,630.00 $ 23.73 $ 15.08 41.5% 12.4 0.7 4.2 6.6 16.1 4.7 2.1% 2.0% 17.3% 24.2% -1.9% 0.7% -1.7% -21.0% -4.3% 8.3% 0.9 1.8 60.4 62.4 37.9% 37.8% 11.3% 10.5% 6.7% 6.6% 12.7% 12.4% 28.0% 21.1% 0.0 4.1 1.9

Multiples
P/E(TTM) P/S(TTM) P/Tang BV(MRQ) P/CF P/FCF(TTM) EV/EBITDA(TTM)

Dividends
Div Yld Div Yld - 5yr avg Div 5yr Grth Payout Ratio(TTM)

Growth Rates
Sales(MRQ) v 1yr ago Sales(TTM) v 1yr ago Sales 5yr Grth EPS(MRQ) v 1yr ago EPS(TTM) v 1yr ago EPS 5yr Grth

Balance Sheet
Quick Ratio(MRQ) Current Ratio(MRQ) LTD/Eq(MRQ) Tot D/Eq(MRQ)

Margins
Gross %(TTM) Gross % 5yr Op %(TTM) Op % 5yr avg Net %(TTM) Net % 5yr avg

Returns
ROA(TTM) ROA 5yr avg ROE(TTM) ROE 5yr avg

Efficiency
Rec Turnover(TTM) Inv Turnover(TTM) Asset Turnover(TTM)

On a relative basis, The Gap remains cheap in relation to the multiples. It offers a 2% dividend yield which is higher than both TJX and ANF. A major concern arises when looking at the growth rates, more

specifically the recent growth rates as The Gap has been underperforming its competitors by a huge mark in this criteria. Investment Valuations Reverse DCF Starting with a reverse DCF valuation, I will assume a discount rate of 12% and a terminal growth rate of 1.5%. (The terminal growth rate of any company should never be higher than the growth rate of the economy.) A reverse DCF valuation should be used just to see a rough picture of where the market has currently priced The Gap based on fundamentals. Based on my assumptions the market has currently priced The Gap to have a owners earnings FCF growth rate of around 4.6% year after year for the next 10 years, where then it will grow at its terminal growth rate. This is a rough estimate number, however this is way below its 5 year historical averages and fairly above its 10 year historical averages. FCF growth is best to be looked at over multi-year periods as it is very volatile on a year to year basis. Actual Owners Earnings DCF This is the heart of my valuation of a company. I believe that a more reasonable estimate of around 4% growth for the next 10 years with it slowing down in the later years is more accurate. I have also adjusted the owners earnings FCF as the trailing twelve months amount has decreased significantly from the 2011 annual statement and I have adjusted it with an increase towards historical average. Under my assumptions, I believe the intrinsic value to be around $22.05 on the safe side and on the more optimistic side with increasing growth it can be up to $24.14. For The Gap, I believe at this point of time the conservative DCF is the way to go or at least until more information is released about Athleta.

Note, it says buy under $11.02 this is not a strict rule it is just the price which generated a margin of safety of 50%.

30 25 20

5 Yr Price vs Intrinsic Value

15 10
5 0 31/05/2005 31/05/2007
Historical Price

31/05/2009
Intrinsic Value

31/05/2011
Buy Price

The above image is with a 50% margin.

30 25 20

5 Yr Price vs Intrinsic Value

15 10
5 0 31/05/2005 31/05/2007
Historical Price

31/05/2009
Intrinsic Value

31/05/2011
Buy Price

The above image is with a 25% margin.

Graham Valuation Under the graham valuation model, I also believe The Gap to be fairly valued. I have adjusted the fiscal year 2012 EPS to the average analyst estimate of $1.54 per share. This model is only used for confirmation with other models.

FCFE Valuation Under the FCFE valuation I consider The Gap to be also fairly valued. The growth rate for this model is built around fundamentals, where it is equal to the non-cash return on equity multiplied by the equity reinvestment rate. Reason being that we do not want to just guess a growth rate and it is better to get one from fundamentals, obviously the option to adjust these ratios can occur if needed. According to this model, the intrinsic value is roughly around $24.11, which is in line with our actual owner's earnings DCF. Technical Analysis My reports are strongly on the fundamental side but I have studied technical analysis in the past and I think it is good to just briefly bring it up. Looking at the chart below it is obvious that the stock has found a resistance point at around the $15.00 level. Therefore, if the price were to drop to around $15.00 even though the margin of safety is just around 32%, I would consider investing at this price level due to the resistance it has previously found at this level.

Overview I believe that The Gap is a solid company with good fundamentals. However, I am not confident with the amount of growth they have left looking forward and I also believe the market price for The Gap to be fairly valued. I also am waiting for more information to come about the growth opportunities of the Gap's newest retailer, Athleta. I would not invest in The Gap at these current levels. Best Regards, Matthew

Matt's Fundamental Stock Analysis

Content Disclaimer: I am only a retail investor and I only intend these reports to be used as a guidance. I recommend you do your own research as this will better help you to understand how companies work and operate and what drives their growth. What stocks you decide to purchase, should be chosen by you and this report is made only to display companies which I think are worthwhile to look at and discuss. Just because it is a good company or I like the company does not mean that it will do good in the future. If you want to copy or replace my report, please do so with a link connecting to my blog.