GPS: One Big Circular Reference

SG&A cuts have gone from fat, to muscle, to bone. Inventory improvement is officially tapped. GPS must comp, but needs the talent (SG&A) to do so, as well as the inventory. Numbers are too high.

I think that there’s such a massive fundamental disconnect at GPS. How could a company comp down 28% over 4-years, while leveraging SG&A and sustaining gross margins? It all lies in cuts to SG&A and working capital. I’ll give it to GPS on working cap. They’ve brought down inventory to 70 days, which puts them in the top 10% of retailers as it relates to inventory management efficiency. But SG&A is scary. The company had already been losing design, marketing and merchandising talent BEFORE the double digit SG&A cuts of the past year. First GPS cut into fat, then 3 years ago it hit muscle, last year it struck bone, and now it is sawing away (sorry for the foul visual…).

What does all this mean? Well…as indicated in our SIGMA chart below, this company is in a precarious position. Sales have been consistently growing faster than inventories with positive margins, but inventories got out of whack last quarter. Now we’re at a point where I don’t believe inventories can come down anymore. What does that mean? Yes, for the first time in 5 years, Gap actually needs to comp. But the only way to comp is to 1) pump in the appropriate inventory that is 2) designed, merchandised and sourced by the tight list of people who actually have the qualifications to do this at a company that is structurally too large to be fast and accurate.

I don’t get it. I don’t see how Gap earns a buck this year. The consensus is at $1.14. In fact, without a massive reallocation of capital (to either SG&A or some capital project that I am not smart enough to think about now), I don’t see how Gap ever earns over $1 again (yes, earnings would need to come down before they can go up again).

Full disclosure: Here’s a trading callout from Keith that is a risk to being short.
Shorts not a huge factor driving this (less than 4% of float is short), but you might want to check the seq change in short interest base across the last 3-6-9 months… All insiders do at this company is sell obviously – but looks like the Fisher’s remain on a program.

All of the big holders were mutual funds and look to have yacked it on the lows – no one is ALLOWED to own a dog like this for this long … not one holder is north of 5% of the shares anymore other than the Fishers. This is actually a very positive factor if there’s any kind of a turn to call in this business; people wouldn’t/couldn’t afford to miss a stock with this kind of cap move higher, sustainably.


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