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Mine the Gap: Analysts’ Love for the Retailer Only Grows

The Exchange

Wall Street has been admiring the turnaround at Gap (GPS) for some time, repeatedly showering the clothing retailer with praise over its operations and prospects. On Wednesday, Citi kept the upbeat commentary going, lifting its rating and price target on the stock.

Gap store

FactSet data show that Gap already had been the recipient of at least 30 price target increases this year. Several came last week, after the San Francisco-based apparel seller said first-quarter sales rose 7% from the same quarter a year ago to $3.73 billion.

While a handful of cuts have been issued along the way, by and large, optimism abounds. In the case of Citi, the firm gave Gap a buy rating, up from neutral previously, and boosted its target by $8 to $48 a share, making it one of the more elevated projections on the record. On average, analysts' target price on the stock is $43.10.

The highest is $56 at Jefferies. That's not only 30% ahead of the consensus price, it's also better by almost $3 than the all-time closing high of $52.88 in early 2000.

Gap's shares have run past multiple projections during their ascent, burying any doubters along the way. Perhaps as a result, shorts have decided it's simply best to look elsewhere: Short interest has fallen 36% in the last month and now equals 1.9% of the float, according to Yahoo Finance data. Longs, meanwhile, have celebrated. The stock has advanced 31% from where it ended last year, double the S&P 500's 16% gain in that time frame. Going back to the final day of 2011, the stock has surged 126%.

With all these high expectations in the analyst community and eager buyers in the market, a contrarian might think that, even if wrong before, it's about a fair time to be pessimistic.

The (generally) good

But is it? Clothing sellers as a group are drawing in shoppers, if government data tell the right story. Earlier this week, the Census Bureau said the advance estimate for April found total retail sales were up 0.1% from March, while clothing and accessories stores performed better, with sales rising 1.2% vs. the month earlier and 5.7% from the previous year to $20.6 billion.

The chart below illustrates the trend:

Clothing sales

Source: Census Bureau

Retail sales help reflect the state of the economy overall. In lean times, items that are nice to have, but not necessary, start getting postponed or skipped altogether, casual and semi-business apparel among them. For the last year, the amount spent on clothes has been rising steadily.

The most recent consumer confidence reading from The Conference Board signaled improvement, too. These findings can change from month to month, though if it stays here or keeps climbing, it would suggest retailers have reason to be hopeful about their patron counts.

Positives, yes, and data one could use to support the argument that Gap's prospects are bright.

Still, signs aren't overwhelming that the consumer is ready to embrace profligacy. Broader reports point to some growth for the U.S., not an economy that's ripping ahead. The initial gross domestic product figure for the first quarter increased at a 2.5% yearly pace, but missed expectations. Jobs are being created, albeit not at a rapid rate, and while the official unemployment rate is well beneath its recession high, it's still 7.5%.

Of course, that less-than-brisk economy hasn't stopped the Dow Jones Industrial Average and S&P 500 from hitting all-time highs. If the last four years haven't convinced you of the stock market's role as a predictive mechanism, probably nothing will.

Key for Gap is whether these larger forces will allow it to maintain the pace it's set. Its stock is trading at a 14.7 forward price-to-earnings ratio, above the five-year average of 12.3, FactSet shows. In its favor is the fact that it's below the 16.2 high of the last half decade, and it's not expensive relative to its peers when viewed by P/E. Urban Outfitters (URBN) has a multiple right at 22, and Aeropostale (ARO) is around 28. Abercrombie & Fitch (ANF) matches Gap at 14.7, while American Eagle (AEO) comes in lower, at 13. Green cells highlight the category leaders:

Gap comparisons

Source: FactSet. FY2013 sales in millions of $. Gross and net margin are for FY2013. Sales and net growth are for FY2013 over FY2012.

Note that Gap, which includes its namesake stores, as well as Banana Republic and Old Navy, is larger than the other four combined in terms of revenue.

The (potentially) bad

Here's where questions emerge. For a number of other metrics beyond P/E, Gap also trades above its five-year average, though generally more so than the peer set. The green cells below indicate where the current level is above the average, and orange represents below:

Gap valuation

Source: FactSet

These ratios could be taken as some measure of evidence Gap's appreciation has gone too far, too fast. Year to date, its stock performance has led all of the above, and it has outshone retail generally. Using the SPDR S&P Retail (XRT) exchange-traded fund as a proxy, the group is up 24% since January started, seven percentage points behind Gap. It exceeds the consumer discretionary names by an even greater amount -- the Consumer Discretionary Select Sector SPDR (XLY) ETF has added 19%.

With this said, the average price target, $43.10, is only 5.1% above where the stock closed Wednesday. That's not exactly putting Gap's followers in the realm of the insanely enthusiastic right now. If the norm suddenly leaps to the mid-$50s (for instance) the conversation becomes something else.

Because of its share price increase, dividend raise, strong earnings and other factors, Yahoo Finance named Gap the company of the year for 2012. This year, it's followed a similar path, projecting more EPS growth, lifting its dividend again and continuing to repurchase stock. For the current fiscal year that ends in January 2014, analysts predict revenue of more than $16.2 billion.

There's nothing wrong with a given company outperforming its rivals. The market searches for the best stocks in an industry and rewards winners. Does Gap deserve where it's been the last year and a half? It's come a long way since the dark times of the early 2000s, when its comparable sales were in free-fall. Results indicate its stores are appealing to customers today, so even if it is more richly valued than like companies, investors are fine with paying for its expected further success, just as analysts are betting on the same.

Clearly, they've not been let down thus far. To stay aloft, Gap only needs to prove the comeback is here to stay.

You tell us. Is Gap back, or is the success temporary, making the shares too pricey?