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Gap shares surge 24 percent as Wall Street praises split

FILE PHOTO: A Gap Inc. retail store is shown in La Jolla, California, U.S., May 17, 2017. REUTERS/Mike Blake

By Nivedita Balu

(Reuters) - Gap Inc shares surged as much as 24 percent on Friday as a number of Wall Street analysts lauded the company's decision to separate its better-performing Old Navy brand.

The company, once a trend setter with its casual logo emblazoned hoodies to Khaki cargos, has struggled to keep pace with fast-fashion rivals such as Zara and H&M.

Old Navy has been the only bright spot for the company in the past few years, cushioning it from the weak performance of its namesake Gap and Banana Republic brands, where sales have also taken a hit from fewer additions of new designs.

"Separating Old Navy to a standalone company is what we have argued for over the past few years. Doing so allows the market to properly value Old Navy for its high margins and strong cash flows," Jefferies analyst Randal Konik said.

Konik said separating Old Navy, which is the primary driver of profit for Gap, would also make the budget brand as attractive as off-price retailers such as TJX Co Inc and Ross Stores.

"We are buyers," Konik said.

The gains in the stock set it up for its best day in more than 10 years and added about $2 billion to the company's market capitalization.

Gap said on Thursday that Old Navy would be spun off to its shareholders, while the other entity will consist of the Gap brand, Athleta, BR, Intermix and Hill City.

"Santa didn't bring the sales but brought Old Navy spin instead," RBC's analyst Kate Fitzsimons said.

At least four brokerages raised their price target on the stock, with Telsey making the most bullish move by raising its price by $6 to $40, well above the median of $30.

The company also said it would close hundreds of underperforming Gap stores in the next two years and would increase investments in its online business as they try to adapt to a more modern retail environment.

It has already shut its massive flagship store on Fifth Avenue in New York earlier this year.

On a post-earnings call with analysts on Thursday, Chief Executive Officer Art Peck said the company would focus on quality, fit and style of apparel that today's consumer needs, with special focus on denim to boost the Gap brand.

The company also said it plans to invest more in fleece for spring, summer and fall seasons.

At Old Navy, the fashion is already more resonant with the latest styles, with blouses and dresses priced as cheap as $30.

"You can have confidence that we definitely boil the ocean in looking at all the combinations and permutations here ... We settled on this largely due to the business logic at the end of the day," Peck said referring to the split.

While analysts were encouraged by Thursday's announcement, some said concerns around the company's money-losing Gap brand would remain.

"While we are encouraged by the decision, we would note the company's brands continue to face intense competitive pressure, particularly in the U.S.," Guggenheim analyst Robert Drbul said.

Gap's shares lost a fifth of their value in the past 12 months, while the broader S&P 500 Apparel Retail index rose 13 percent.


(Reporting by Nivedita Balu in Bengaluru; Editing by Sweta Singh and Saumyadeb Chakrabarty)