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Gap Inc. (GPS): Zacks Rank Buy

Todd Bunton

Estimates have been rising for Gap Inc. (GPS) after the company delivered its 5th consecutive positive earnings surprise.

It is a Zacks #2 Rank (Buy).

Gap maintains a solid balance sheet and generates strong free cash flow, which has allowed it to buyback millions of shares of its stock while also consistently raising its dividend. It currently yields a solid 2.0%.

Valuation is attractive too with shares trading below the industry median on several metrics.

Company Description

Gap Inc. is a specialty retailer operating the Gap, Banana Republic, Old Navy, Piperlime, and Athleta brands. It operates over 3,000 stores and franchises over 200 more primarily in North America, Europe and Asia.

It is headquartered in San Francisco, California and has a market cap of $12 billion.

Fourth Quarter Results

Gap delivered better than expected results for the fourth quarter on February 23. Earnings per share came in at 45 cents, beating the Zacks Consensus Estimate by 2 cents. However, it was a 27% decline from the same quarter in 2010.

Net sales fell 2% to $4.283 billion, but it was in-line with the Zacks Consensus Estimate. The decrease was due to a 4% decline in same-store sales.

Gross profit fell sharply, from 38.2% to 32.8% of net sales, due to rising input costs. This was partially offset by a decline in operating expenses, leading to a 37% drop in operating income.

Earnings per share was boosted in part by a 20% lower share count as the company continues to buy back stock.

Outlook

In its Q4 press release, management gave a bullish outlook for 2012. The company expects to earn between $1.75 and $1.80, which was ahead of consensus at the time. This prompted analysts to revise their estimates higher, sending the stock to a Zacks #2 Rank (Buy).

The Zacks Consensus Estimate for 2012 is now $1.83, representing 17% growth over 2011 EPS. The 2013 consensus estimate is currently $2.01, corresponding with 10% EPS growth.

Returning Value to Shareholders

One of the ways the company will grow EPS is through big stock repurchases. In 2011, for instance, the company bought back approximately 111 million shares for a total of $2.1 billion. And the company also announced a new $1 billion share repurchase authorization that replaces a previously announced authorization.

In addition, the company announced an 11% increase in its annual dividend to 50 cents per share. It currently yields a solid 2.0%.

As you can see in the chart below, the company has increased its dividend at a compound annual rate of 15% since 2000:

GPS: Gap Inc.

Reasonable Valuation

Valuation looks reasonable for GPS, with shares trading at 13.6x 12-month forward earnings, a discount to the industry median of 17.3x and its 10-year median of 14.4x.

Its price to sales ratio of 0.8 is also below the industry multiple of 0.9 and its historical multiple of 1.0.

The Bottom Line

With rising earnings estimates, strong growth projections, shareholder-friendly management, a 2.0% yield and reasonable valuation, Gap offers investors a lot to like.

Todd Bunton is the Growth & Income Stock Strategist for Zacks Investment Research and Co-Editor of the Reitmeister Value Investor.

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