We think that GPS hiring Michael Francis, recently fired CMO and confidant of Ron Johnson at JC Penney, as a strategic advisor is extremely telling. Think about it like this…
Make no mistake, this has been a financial engineering story over the past 8-years. Basically, buying back stock. $11bn in repo has taken down the share count by 47%. As recently as 3-years ago, GPS was sitting on a net cash position of $2.3bn. Now it is down to $400mm. In other words, this did not need to be an operational improvement story to grow earnings. Now the share repo angle is largely over. GPS absolutely NEEDS to show consistent comp and/or margin improvement.
At the precise time that they needed to perform, two things happened.
1) The company ‘hit a fashion trend’ with its colors. I’m still not sure what that means. Hitting a fashion trend is pretty much useless. Having a process to sustain driving fashion trends (Ralph Lauren, Nike) is a completely different issue. GPS hit fashion because it was lucky, not because it was good.
2) JC Penney imploded at that exact same moment. When one of the largest apparel retailers in the country comps down by 20%+ and hands off $3bn in sales to the lowest bidder, it is absolutely positive for GPS. Some people think that Gap’s biggest competitors are specialty apparel retailers – even the teen and adolescent retailers. Not true. GPS is basically a department store. The company competes head to head with JCP. In fact, when JCP started comping down, its top competitor, Kohl’s, ALSO comped down. Virtually all of the share was picked up by Macy’s, GPS, TJX, and ROST.
Though we think that JCP is terminally ill, the reality is that its business will ebb and flow along the way. The second that it stops ebbing, then these companies -- particularly GPS and M will stop gaining share on the margin – which is all that this P&L needs to start choking on itself.
So this takes us back to the Michael Francis hire. What does this tell us? Well, on one hand, it tells us that GPS is being proactive in getting as smart as possible as to how JCP will be going to market with its new strategies. That way, GPS can pre-empt, or even just cope appropriately when certain initiatives come to fruition.
But on the flip side, it shows just how vulnerable it is and how much it is downplaying the JCP threat. Check the last conference call transcript. Search for the name ‘JC Penney’. You’re not going to come up with much. They’re completely playing down to the street how much this has been helping them.
Are they flat-out lying? Probably not. We’re not crying conspiracy theory here. But the reality is that they simply don’t know. Do retailers know why people buy their goods? Why they walk past the door and go to the next retailer? They really don’t. The only one that likely can is Wal Mart. Amazon is a close second. Costco and Target round out the top. It falls precipitously from there. GPS simply does not know (and JCP does not know either). That’s why this industry has always been plagued by companies having to compete away what is near-universal previously-held optimism around sales and margins.
Ron Johnson announced this week that the company had logged in 1.6mm free haircuts at JC Penney stores this Back-to-School. Now that the former head of marketing is advising GPS, maybe we’ll see free waxing at Athleta, and Man-scaping at Banana. They’re gonna need it…no joke.
The consensus has GPS earning $2.40 next year. Then $2.72 the year after. We’re about 10% below next year, and 20% below the year after. We’d argue that barring a disproportionately large capital investment (which would drive returns lower) GPS will never see $2.50 again – ever. And as we say at Hedgeye, ‘ever’ is a long time.
That did not matter with the stock trading at $15 a year ago. But it certainly matters today at $35. Let’s say we’re dead wrong, and the Street is spot-on. Then you’re paying 12.9x earnings for a number that GPS will earn in FY 2014. That’s right up there with AAPL, NKE and RL. Which would you rather own?