ModernGraham Valuation: Gap Inc. (GPS)

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Company Profile (obtained from Google Finance): The Gap, Inc. (Gap Inc.) is a global specialty apparel company. Gap Inc. offers apparel, accessories, and personal care products for men, women, children, and babies under the Gap, Old Navy, Banana Republic, Piperlime, and Athleta brands. It operates in two segments: Stores, which includes the operations of the retail stores for Gap, Old Navy, and Banana Republic, and Direct, which includes the operations for its online brands, both domestic and international. It has Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, China, and Italy. It also has franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores throughout Asia, Australia, Eastern Europe, Latin America, the Middle East, and Africa. As of January 28, 2012, the Company had 3,263 store locations, of which 3,036 stores were Company-operated and 227 stores were franchise store locations. In March 2012, the Company opened its store in South Africa.

Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?):

Defensive Investor – must pass at least 6 of the following 7 tests: Score = 6/7

  1. Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
  2. Sufficiently Strong Financial Condition – current ratio greater than 2 – PASS
  3. Earnings Stability – positive earnings per share for at least 10 straight years – PASS
  4. Dividend Record – has paid a dividend for at least 10 straight years – PASS
  5. Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – PASS
  6. Moderate PEmg ratio – PEmg is less than 20 – PASS
  7. Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL

Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 5/5

  1. Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – PASS
  2. Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – PASS
  3. Earnings Stability – positive earnings per share for at least 5 years – PASS
  4. Dividend Record – currently pays a dividend – PASS
  5. Earnings growth – EPSmg greater than 5 years ago – PASS

Valuation Summary (Explanation of the ModernGraham Valuation Model)

Key Data:

MG Value $61.50
MG Opinion Undervalued
Value Based on 3% Growth $31.50
Value Based on 0% Growth $18.47
Market Implied Growth Rate 5.18%
NCAV $0.26
PEmg 18.86
Current Ratio 2.01
PB Ratio 5.54

Balance Sheet – 7/31/2013 

Current Assets $4,586,000,000
Current Liabilities $2,278,000,000
Total Debt $1,247,000,000
Total Assets $7,920,000,000
Intangible Assets $280,000,000
Total Liabilities $4,462,000,000
Outstanding Shares 468,000,000

Earnings Per Share – Diluted

2014 (estimate) $2.65
2013 $2.33
2012 $1.56
2011 $1.88
2010 $1.58
2009 $1.34
2008 $1.09
2007 $0.93
2006 $1.24
2005 $1.21
2004 $1.04
2003 $0.54

Earnings Per Share – Modern Graham (Calculating EPSmg)

2014 (estimate) $2.17
2013 $1.87
2012 $1.59
2011 $1.52
2010 $1.31
2009 $1.17

Conclusion:

Gap Inc. is a very attractive company for both Defensive Investors and Enterprising Investors.  The company has very strong financials, having passed all of the requirements for either investor type, with the exception of the price to book ratio requirement of the Defensive Investor.  From a valuation perspective, Gap has grown its EPSmg (normalized earnings) from $1.17 in 2009 to an estimated $2.17 for 2014, and has done so through consistent annual growth.  As a result, the ModernGraham valuation model looks very favorably on the company, and it appears to be undervalued with respect to the market’s implied growth rate of 5.18%.  Potential investors should feel comfortable doing further research on this company (though, as always you should speak with a registered broker or investment advisor before making any decisions based on your individual portfolio!).

What do you think?  Is Gap Inc. undervalued?  Is the company suitable for both Defensive Investors and Enterprising Investors?  Leave a comment or mention @ModernGraham on Twitter to discuss.

If you like our valuations, why not check out ModernGraham Stocks & Screens?  It’s a great way to review the valuations while screening for things like low PE ratio, undervalued companies, etc.!

Disclaimer:  The author did not hold a position in Gap Inc. at the time of publication and had no intention of entering into a position within the next 72 hours.

Photo Credit:  Andrew Magill


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