This Unloved Value Play Is Hiding In Plain Sight

Shares of retailers have struggled to hold on to gains this year, even as the rest of the market enjoys record highs. 

Employment growth has only just started to turn higher and real hourly wages fell for almost every segment of the workforce during the first half of the year. Against the backdrop of sluggish sales and the unknown of the holiday shopping season, you probably wouldn’t be surprised if retailers played it safe with their advertising as we move through third quarter earnings.

But one retail giant is stepping out into the limelight with a new series of ads directed by an up-and-comer from one of America’s most celebrated movie families. 

#-ad_banner-#Instead of putting out the traditional drivel of holiday hopes and dreams, the company is taking a chance on something memorable enough to move the needle on sales. 

While holiday sales disappointed investors last year, things are looking up for the upcoming shopping season and this company’s striking new ads may bring buyers back in a big way.

Can ‘Endearingly Weird’ Save This Fashion Heavyweight?

The Gap, Inc. (NYSE: GPS) shares plunged 12.4% on October 9 with the release of flat September same-store sales and the announcement of long-time CEO Glenn Murphy’s departure. Sentiment in the shares had been weak since early September, but the announcement was the last straw as analysts rushed to downgrade the stock.

As usual, Wall Street analysts’ focus on past events may be blinding them to more recent news that could take the shares higher.

Sophia Coppola directed four new ad spots that are getting a lot of buzz on the internet. The ads, launched November 3, are part of the company’s “Dress Normal” campaign that pushes the ‘real’ experience of the holidays instead of impossible dreams like a Lexus in every driveway.

Sophia is quickly rivaling her father — the famed director of The Godfather — for awards, being nominated for multiple Academy Awards for her 2003 film Lost in Translation and winning the Oscar for Best Original Screenplay. 

If she can bring her quirky genius to the series of Gap ads, then it could just make them memorable enough to make a difference against the onslaught of cookie-cutter commercials this holiday season. AdWeek named the commercials to their Ad of the Day list and called them, “endearingly weird.”

Brand Power And Deep Value
Despite lackluster same-store growth recently, the company still owns three of the strongest brands in casual apparel: The Gap, Old Navy and Banana Republic. The company has delivered an average 14% annual adjusted return on invested capital over the last three years and is smartly restructuring to focus on growth in online sales. 

The company cut nearly six million square feet of retail space from its poor performing North American presence and is expanding through franchises and internationally. Online sales have doubled over the last five years to 13% of total sales in 2013.

Gap is wrapping up an investment cycle to improve its supply chain and online customer experience. The company spent an average of $664 million annually on capital expenditures over the last two years, more than $100 million more than the average over the preceding two years. Spending could come down toward the middle of 2015 and margins should start to improve.

Revenue dropped 2% to $4.6 billion in the fourth quarter of 2013, but is expected to rebound 4% to $4.8 billion for the fourth quarter of this year. In a recent article, I made the case for surprising strength in holiday sales this year. The National Retail Federation forecasts 4.1% sales growth, but I think an improving employment picture and cheap gas prices could have companies ringing the register this year.

The company has a strong history of beating estimates — exceeding expectations for 15 consecutive quarters. Shares trade for 14.2 times trailing earnings against an industry average of 22.2 times. Earnings are expected 14% higher next year to $3.19 per share. A price multiple of 15.0 times on improved sentiment yields a one-year target of $47.85, a gain of 25% on top of the 2.3% dividend yield.

Risks To Consider: Same-store sales weakened this year — especially at the flagship store where sales are down 5% year-to-date. The holiday season will be pivotal for the company and shares could be volatile around the release of same-store sales data.

Action To Take –> Shares of the Gap have been unloved lately, but the company’s holiday ad campaign could reinvigorate the name. Earnings are expected higher by double-digits next year and investors should take a position before sentiment turns higher.

Sometimes the little ideas are the big game-changers — something like a unique ad campaign. StreetAuthority compiled a list of what we believe are the next great trends called “The Hottest Investment Opportunities For 2015.” For more information on the game-changing idea that could move the markets and change the world, click here.