Gap Earnings: Nice Start to New CEO’s Tenure as Old Navy and Margins Outperform; Shares Undervalued

Gap delivered third-quarter sales and earnings above our expectations, providing a dose of optimism in CEO Richard Dickson’s first quarter at the helm. While there is much work to be done, we think these results demonstrate that the firm’s efforts to cut costs and close underperforming stores while investing in its brands will bring a return to positive sales growth and mid-single-digit operating margins over the next two or so years. Gap’s shares rallied by 16% in Nov. 16 post-market trading on the report but remain well below our $23.50 fair value estimate, which we expect to raise by a low-single-digit rate. Although we assign a no-moat rating to Gap due to its chronic underperformance and the competitiveness of the U.S. apparel market, we believe it has strengths, such as the high awareness of its brands and their value proposition to consumers.