Gap is still in disrepair after scrapping Old Navy fallout

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Difference (NYSE: GPS) was caught between the proverbial rock and the anvil. After agreeing to split the Old Navy chain to help raise funds to pay off its heavy debt, the jeans and khaki retailer was forced to cancel the deal as the discount store’s business collapsed.

If Gap had stayed the course, the spin-off would likely have been a failure because stumbling companies don’t excite investors, and he wouldn’t have raised enough money to pay underwriters and his debt. But canceling it means he still has his debt and is stuck with a struggling retailer that he now needs to rehabilitate.

Image source: Gap.

There weren’t any good options available, but the one Gap chose is probably the best. However, as the retailer himself is not in his best shape and still has many issues to contend with, investors should steer clear of his stock.

Take water quickly

The Old Navy spin-off made a lot of sense when Gap first proposed it. The discount retailer was the Gap family workhorse of stores, reliably posting higher sales quarter over quarter, while the namesake Gap brand and the Banana Republic brand have seen same-store sales plummet consistently.

But shortly after the spin-off was announced, the Old Navy’s business, which was already starting to weaken, quickly turned negative too much. Now all three companies regularly report negative compositions.

Comparable sales graph of the three Gap chains

Data source: Gap SEC documents. Chart by author.

While Gap maintained his commitment to the separation, the third quarter earnings report saw him oust his CEO, and from that point on, it only seemed a matter of time.

There are no good arguments left

Art Peck had run Gap for five years, but by that time the retailer’s inventory had lost more than half of its value. While he had turned Old Navy into a fast-paced fashion retailer capable of quickly swapping styles as consumer whims changed, he couldn’t conceive of a similar reinvention with the other two brands and has then abandoned the quest.

Yet the separation of the Old Navy from Gap was also an idea he supported, and with Peck no longer in the captain’s seat, the plan was somewhat leaderless.

Add to that the channel’s declining fortunes and it was almost inevitable that the idea would be scrapped. Gap, however, now has more issues that make it questionable how long he can survive.

Facing a position of weakness

Gap reported long-term debt of $ 1.25 billion in the third quarter, and a successful spin-off would have helped reduce that amount significantly, even though technically it was the company being split up (Old Navy was the remaining activity and that would have changed the name of the company).

J. Crew, also in debt, is IPO planning his Madewell denim chain to help him pay off $ 1.7 billion in debt and keep him from going bankrupt. But unlike Old Navy, Madewell continues to perform well, even though it will go public in an increasingly competitive denim market.

Gap doesn’t have the luxury of a solid business, and with an estimated cost of $ 700-800 million to fund the spin-off, it needed a healthy Old Navy to attract enough investors to make it happen. works. The totality fast fashion wave May have run its course as well, and worse yet, Gap is in turmoil with no frame at the helm. It also does not have a clear recovery plan in place.

One last breath

However, giving him some breathing space has been a better than expected holiday season, even at Old Navy. In the statement that Gap was pulling the spin-off, he raised his forecast for the full year: “Due to better than expected promotional levels over the holiday season, particularly at Old Navy, the company is Now expects its adjusted earnings per share for fiscal 2019 to be slightly above its previous forecast of $ 1.70 to $ 1.75. “

Even so, the builds are still expected to be negative, although Gap said it would be in the upper end of its earlier forecast which predicted medium to low single-digit declines. It is not a healthy business.

While the markets have supported Gap’s shares on the news, all of the issues the retailer previously had remain, and it is now also stuck with the Old Navy brand. Because their businesses are so similar, although one is a discount chain, it serves to cannibalize the sales of the other. It is always going to be the case now, and investors would do well to stay away.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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