GPS | The Final Straw

If there was anything redeeming about this GPS quarter, we can’t find it. Absolutely horrible numbers. Total sales down 13% with inventories ending the quarter +34% -- yeah that’s a -47% sales/inventory spread, which is toxic for gross margins for the balance of the year. If there’s only one statistic you need to know here, that’s the one. Even the crown jewel – Athleta – only put up 4% top line growth. Old Navy (which is 55% of sales) was down an astonishing 19%, with Gap not too far behind at -11%. Banana actually put up a respectable performance (more dressy apparel, which is where the consumer is going) was +24%. The sales miss was largely known given that company’s pre-announcement. But the gross margin hit of 930 basis points was new, and an absolute disaster.  We added this name to the bottom of our Long Bias list when the company first announced the sales miss at Old Navy – due to our view that this is as prime a target as you can find for an activist to step in and 1) clean house, and 2) spin off Athleta. Does the 4% growth rate in Athleta derail that story? We definitely don’t think so. It went against an extremely difficult comp vs last year and is still running 60% ahead of pre-pandemic levels. We think we’ll see an acceleration – a very meaningful one – throughout the year and then approaching 20% next year. There’s line of sight for $2bn in sales at Athleta at a high-teens EBITDA margin. So we’re talking $350mm-$400mm in EBITDA over 2-3 year time period when the parent company is going to be lucky to generate $500mm in EBITDA this year. We’d give Athleta a 10-12x EBITDA multiple, which suggests about a $4.2bn EV. Right now, the entire GPS business is trading at a sub-$4bn EV. Last we checked, the Fisher family still owns 40% of the outstanding stock. It’s unfathomable to us that the family can’t or won’t unlock that value. They tried once with Old Navy, and then scrapped the plans as separation costs were too high. But Athleta is no where near as integrated into the GPS portfolio as Old Navy is, and separation costs would be completely manageable. The CEO’s answer to the ‘why not separate Athleta’ question was absolutely unacceptable. There's minimal synergies, and certainly not enough to justify the continued equity value destruction with a quality asset being dragged down by losing businesses. The CEO of Old Navy took the fall and lost her job over this miss, but that firing event should have started at the top – yes, GPS CEO. The C-suite is failing miserably, and should be replaced. Again, this name is ripe for an activist to step in, rightsize the business, and spin out Athleta. If there’s any good news here its that the company set earnings expectations to a level it very likely won’t miss. But the better news is that things are simply so bad that it could finally lead to the right parties getting involved to break up the company and get something done here. Let’s see where the stock trades tomorrow, but we’re inclined to take this name higher on our Long Bias list (it will likely never be a Best Idea) as the vultures use this disaster of a print to start circling.