Gap Inc.: A Strong Buy

Zacks

Impressive fiscal third quarter 2012 (ended October 27, 2012) results, which matched the Zacks Consensus Estimate, as well as high earnings estimates helped Gap Inc. (GPS) achieve a Zacks #1 Rank (Strong Buy).

Since the release of its third-quarter results on November 15, shares of this premier international specialty retailer have increased about 5.7%. Moreover, considering its robust growth (year-to-date return of approximately 92.0%) and the history of beating quarterly earnings estimates (including an average beat of 3.0% over the trailing four quarters), this stock represents an attractive investment opportunity.

The Rank Driver

Sturdy fiscal third quarter 2012 earnings, healthy comparable-store sales, effective cost management and rising earnings estimates are the primary rank drivers for this stock.

Gap, which competes with Ross Stores Inc. (ROST), posted third-quarter earnings of 63 cents a share, in line with the Zacks Consensus Estimate and surged 66.0% from the year-ago quarter’s earnings of 38 cents. During the third-quarter, Gap’s net sales increased 8.0% year over year to $3.864 billion from $3.585 billion in the comparable quarter last year. Moreover, quarterly sales surpassed the Zacks Consensus Estimate of $3.841 billion.

The robust performance was backed by improved margins and healthy comparable-store sales growth of 6% against a 5% decline in the third quarter of 2011. Further, management’s cost cutting initiatives are helping the company to reduce costs and boost profitability.

Healthy quarterly performance has prompted management to raise its fiscal 2012 earnings guidance. The company now expects earnings in the range of $2.20–$2.25 per share for fiscal 2012, an increase of 41%–44.2% from fiscal 2011. Earlier, Gap was expecting earnings in the range of $1.95–$2.00 per share for fiscal 2012, an increase of 25%–28.2% from fiscal 2011.

We believe that the company’s relentless focus on turnaround strategies such as lowering domestic store counts while enhancing international stores for improvising the top line is paying off, which reflected on its solid comps and sales performance in the recent months. The company has posted positive comps for four consecutive months (July, August, September and October) this year.

Further, Gap’s long-term strategic moves, along with its disciplined cost management measures has not only provided the company financial flexibility, but also helped it reduce operating expenses. Moreover, Gap’s globally recognized brands complement one another, enabling it to leverage its position in the sector.

Earnings Estimate Revisions

Earnings estimate revisions of the company are exhibiting a positive trend for fiscal 2012 and 2013. The Zacks Consensus Estimate for fiscal 2012 (ending January 2013) climbed 5.0% to $2.29 per share in the last 30 days, reflecting year-over-year improvement of 46.7%. Moreover, for fiscal 2013, the Zacks Consensus Estimate increased 4.1% to $2.56 per share, reflecting an estimated year-over-year increase of about 11.8%.

Valuation

Gap currently trades at a forward P/E of 15.36x, slightly above its peer group average of 14.49x, while its price-to-sales ratio of 1.11 is at a premium to the peer group average of 0.95. With respect to return on equity (:ROE) and return on asset (:ROA), the stock looks attractive. It has a trailing 12-month ROE and ROA of 33.9 and 13.1%, which is above its peer group average of 16.9% and 10.3%, respectively. This implies that the company uses its resources more efficiently than its peers.

About the Company

With over 3,000 stores across the globe, Gap Inc. is a premier international specialty retailer offering a diverse range of clothing, accessories, and personal care products for men, women, children and babies. Its flagship brands include Gap, Banana Republic, Old Navy, Piperlime and Athleta. Approximately three-fourths of Gap’s revenues are generated from its U.S. operations. Headquartered in San Francisco, USA, and founded in 1969, the company has a market cap of approximately $16.9 billion.

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