Shorts just note that GAP bought 24,000,000 shares worth $525MM last quarter at $22 knowing that the year was going to be weak. They also borrowed enough money to buy another 85,000,000 shares last month. Thye still have a pristine BS. At this rate they will have purchased 16% of the company by year end. At that point they will sell to KKR.
Gap has 561M shares out after buying 24MM shares last quarter. At the new $1.50 of earnings for 2011, Cash flow is still $1.4Billion and EBITDA is $1.92 billion. The company value is $10.8 billion @ $19.30. It is still cheao at 5.6 times EBITDA. J Crew was taken out at 8X EBITDA. We can't count on a takeout however.
If they get their margins back in 2012, they would earn $1.2 billion after tax. During 2011 they will buy back another 75MM shares making the outstanding shares 486 million in 2012. They have plenty of cash to do this. Earnings per share would be $2.50 and that assumes no growth. The EBITDA multiple at today's price would be 3.7 x and the free cash flow yield would be 13% after $500mm of capex. Nothing is that cheap in retailing even no growth companies. Therefore the stock would have to move higher--probably to 12 x earnings or $30/shr.
They have to solve a few issues in 2011-- margin expansion and merchandising flair. Everybody that sells mostly cotton garments has been hit--Carters, Hanes, Aeropostale, etc.
Note that cotton is so high because of floods in Pakistan and cold weather in China, export restrictions in India and lots of hoarding. Cotton prices are already coming down in May. Corn farmers in the South will plant cotton instead of corn and supply will come into balance as cotton is much higher value than corn. Everybody got caught in the spike in prices but coming down the other side is the opposite--expanding margins for retailers.
Gap is a good bet with 54% upside plus the dividend and maybe 7% downside--I like those odds.
They are shrinking the market cap so when they pass through the cotton prices next year, the earnings will be spread over 32% fewer shares. Stocks over react to bad news --the stock could be 19 or 21 next month. It does not change the outcome. Everything else being equal, earnings per share on the still outstanding shares next year would be 45% higher than without the purchases. Gap will sell out this fall to a private equity firm just like J Crew just did. They will low ball us but we will still get 7 x EBITDA or $30/shr. All the bad news is out.