Gap Inc - MIT by taoyni


									           Analysis of the Gap, Inc.

    Report by Analysts: Jennifer Failla, Marne Schwartz and Elyssa Shaber
Investment Recommendation: BUY                                 February 21, 2000

GPS - NYSE (2/18/00)            $ 43
52 week range                  $ 30 13/16 - 53 3/4        EPS Forecast: GPS
                                                          FYE 1/31       1998A 1999A 2000E 2001E
Revenue (TTM)                   $9,054.4 Mil              EPS              .91  1.17   1.21 1.52
Market Capitalization           $36.588 Bil               Ratios         Firm  Average of Competitors
Share Outstanding               850.9 Mil
                                                          Forward P/E    28.29x                10.57x
                                                          Forward PEG     1.39                   .53
Divi dend Yield                  .21%                     M/B            23.24                  8.27
Institutional Holdings           49% (75% of float)       P/S              4.04                1.19
Avg Daily Trading Volume          3,134,909               Valuation Predictions: GPS

Book Value per Share (12/99) $1.85                        Actual Price          $43
Return of Ave.Equity (LTM)   52.3%                        P/E Valuation         16.06
Est. 5 Years EPS Growth Rate 20.3%                        PEG Valuation         16.47
                                                          M/B Valuation         15.29
Industry                     Specialty Retailing          P/S Valuation         12.71
                                                          EBO Valuation         18.06
DJIA (2/18/00)                      10219.52              DCF Valuation          84.97
S&P 500 (2/18/00)                   1346.09
                                                          Performance: GPS
                                                          Trailing Return %:        1998    1999 YTD
                                                          Relative to S&P 500       109.8     2.1 1.8
                                                          Relative to Competitors    90.4     2.4 8.1

   We have established a BUY rating on the Gap, Inc. for the following reasons:
    -We believe Gap is the best branded specialty apparel retailer of its competitors we
    -Gap's Old Navy & Banana Republic brands are growing their international market presence
    -Gap is a leading Internet player in apparel, enhancing its business through e-commerce
   Gap's broad base of valuable intangible assets not included on its balance sheet, (all
    of its registered trademarked brands and brand equity) are reflected in:
    -its high stock price relative to the other competitors in our analysis
    -its low valuation estimates; the various techniques used don’t account for intangible assets
   We believe that upside potential for Gap exists:
    -Gap intends to maintain and strengthen its brand loyalty by significantly increasing its
    investment in advertising and marketing
    -The company continues to invest in store expansion
    -The company focuses on development of new distribution channels to address changing
    market requirements

      Business Summary: GAP, Inc.                         Competitors:

Gap, Inc. is an international specialty           Abercrombie & Fitch (ANF):
retailer based in San Francisco.                   Sells fashion oriented and casual
Established in 1969, Gap, Inc. employs                apparel
over 110,000 people and operates 2,600             Targets men & women from 15-50
retail outlets in the U.S, Canada, France,            and children 7-14
Germany, Japan and the U.K. under the              Market Cap 1.61 Bil
names Gap, GapKids, babyGap,                      American Eagle Outfitters (AEOS):
GapBody, Banana Republic and Old                   Sells women's & men's casual
Navy Clothing Co. Gap products are                    apparel, footwear, outerwear &
private-label merchandise, made                       accessories
specifically for the company and include           Targets middle-upper/middle income
wardrobe essentials, such as denims,                  between ages 16-34
khakis, and t-shirts. Further, they offer          Market Cap 976.9 Mil
accessories and personal care products            Intimate Brands, Inc. (IBI):
for teenagers and adults. Banana                   Sells intimate apparel, personal care
Republic stores cater to an upscale                   products & fashion apparel
clothing market by offering fashionable            Operates primarily under Victoria's
collections of tailored clothing and casual           Secret & Bath & Body Works brand
dress for men and women. Old Navy                     names
stores target the family oriented market
                                                   Market Cap 7.6 Bil
by selling value priced clothing, while
                                                  Nordstrom, Inc. (JWN):
Gap flagship stores cater to the middle-
                                                   Sells wide selection of apparel, shoes
priced family market. Both the Old Navy
                                                      & accessories for women, men &
and Banana Republic divisions have
been outperforming the three main Gap-
branded chains. The Gap reaches                    Operates over 60 large specialty
foreign customers mainly through its Gap              stores and 20 clearance stores called
stores, however plans to open Banana                  Nordstrom Rack
Republic stores and introduce Old Navy             Market Cap 2.68 Bil
overseas in the near future.                      The Limited, Inc. (LTD):
In addition, in 1997 Gap opened its first          Sells women's, men's & children's
online store at Since then,              apparel, personal care products,
the company's e-commerce capabilities                 sporting goods & accessories
have increased to include web sites for            Operates under Express, Lerner, NY,
all Gap brands. The company's                         Lane Bryant, Limited, Structure,
business follows a seasonal pattern,                  Limited Too & Henri Bendels
peaking over a total of about 10 -13               84.5% holding in Intimate Brand Inc.
weeks during the back-to-school and                Market Cap 6.59 Bil
holiday periods.

           Risks Facing Gap, Inc.               Financial Performance Analysis

    Risk of Rising Interest Rates
    Ongoing Competitive Pressures in         Gap's three brands have a 6% market
                                              share in the $180 Billion U.S. apparel
     the Apparel Industry                     industry. Further, Gap has realized
    Challenging International Retail         some of the best returns on capital for
                                              all retailers. On a trailing four quarters
     Environment                              basis, its return on invested capital is
    Change in Consumer Spending in           45%. This ratio indicates the company's
                                              strong cash generating capability, and
     Apparel                                  reflects the type of returns to expect as
    Change in Consumer Preferences           this growth company continues to
                                              reinvest in its business. GPS sales of
    Trade Restrictions                       11.635 Bil for the 52 weeks ended
    Political/Financial Instability in       January 29, 2000 represent an increase
                                              of 29% over sales of 2.054 Bil for fiscal
     Countries goods are manufactured         1998. The companies YTD comparable
                                              store sales increased 7% over a 17%
                                              increase for the prior fiscal year.
    Future Opportunities for Growth
                                              GPS Financial Ratios:

The Company's continued success               Current Ratio (mrq*)      1.18
depends, in part, upon its ability to
increase sales at existing store locations,   Debt to Equity (mrq*)       .75
to open new stores, and to operate            Return on Assets (ttm)   23.48%
stores on a profitable basis. The
company has initiated a process of            Return on Equity (ttm)   60.32%
integration between Gap and GapKids           Cash to Sales (ttm)      22.24
field organizations to achieve a singular
brand focus, to better serve customers,
work more closely with the community,         Stock Performance (GPS):
and take full advantage of real estate
opportunities. The company plans to
open approximately 550 to 600 new
stores during fiscal 2000, and expects
sq. footage growth in the mid-20%
range. The company's ability to grow
successfully in the continental European
markets will depend on its ability to build
brand loyalty and gain market share in
France and Germany. To expand its
online capabilities Gap established e-
commerce sites for Its Old Navy and
Banana Republic brand names.                        52 Week change +.09%

                                      Summary of Company Valuation:

                                         Valuation Technique:                                                  Price:

Forward P/E Analysis: Obtained GPS stock price using average forward P/E of 5
competitors based on prices from 2/18/00 and EPS estimates1 for 2001. We do not find this
ratio a good measure for valuing GPS, based on the fact that GPS P/E ratio is considerably                     = $16.06
higher than the competitors used.
Forward PEG Analysis: Obtained GPS stock price using average forward PEG of
competitors of .53. The five year industry growth rate of 19.8%, and GPS 5 year LT growth
rate of 20.3%, 2 and GPS EPS from 2001 ($1.52) were used for the analysis. We do not find                      = $16.47
this ratio a good measure for valuing GPS, based on the fact that GPS PEG ratio is
considerably higher than the competitors used.
Market to Book Analysis: Obtained GPS stock price using average market to book ratio of
competitors from 2/18/00.3 We conclude that GPS large amount of intangible assets accounts                     = $15.29
for the discrepancy between the price obtained and their actual stock price. These intangible
assets are not accounted on their balance sheet in their book value, resulting in this under-
valuation. Thus, we do not find this ratio a good measure for valuing GPS.
Price to Sales Analysis: Obtained GPS stock price using average P/S of competitors of
1.194. We found this ratio to be a poor measure of the value of GPS, given the considerably
volatile nature of sales figures in the retail industry.                                                       = $12.71
EBO (Abnormal Earnings Valuation):
Derivation of RGPS using CAPM :
Rf= 5.57          Beta= 1.22                Expected Market Return= 13.5                  RGPS= 15.2%
Obtained GPS stock price by discounting abnormal earnings through the year 2004 and, due                       = $27.48
to the fact that GPS has many intangible assets and will likely sustain similar abnormal
earnings into the future, we estimated a terminal value (perpetuity) based on 2004 earnings
and the CAPM discount rate. BVO was for the fiscal year ended 1999 and dividends were
assumed to be zero. Earnings growth for the first 5 years is based on a growth rate of 20.3%
and constant abnormal earnings ($2.65) through 2007.5
Discounted Cash Flow Analysis:
Obtained GPS stock price by discounting cash flows/share through year 2004. We assumed                         =$84.97
that cash flows grew at the same rate as earnings (no accruals). We estimated a terminal
value (perpetuity) based on the 2004 cash flow figure, the CAPM discount rate and the S&P
500 industry average 5-yr Long Term growth rate of 12.5%, because GPS' growth rate
exceeded their equity cost of capital. We found this ratio to be a good measure of the value of
GPS, because it solely relies on GPS' internal operating performance, rather than that of
Sensitivity Analysis (using different growth rate assumptions):
Pessimistic Growth rate: 15% Price= $68.845
Actual Growth rate: 20.3% Price= $84.97
Optimistic Growth rate:25% Price= $101.78

  Forward P/E Ratio:

    EPS estimates from Quicken
    5 year LT growth rates from Quicken
    M/B Figures from Yahoo finance. Common Shareholder's Equity for GPS obtained from their 3 rd quarter
  10-Q (10/30/99)
    Risk free rate from Wall Street Journal 3 month t-bill 2/18/00. Beta from yahoo finance. Expected Market
  Return based on our own estimate
    GPS 5-yr LT growth rate= 20.3% from Quicken

Company                              Forward P/E Ratio Price 2/18/00 EPS 2001
ANF                                               6.44         14.75      2.29
AEOS                                              9.35         20.56      2.20
IBI                                              12.30         30.13      2.45
JWN                                              10.24         21.00      2.05
LTD                                              14.52         30.63      2.11
Average Forward P/E                              10.57
GPS: forward P/E Price                             $16.06

*EPS estimates and prices from

Forward PEG Ratio:
Average Forward PEG                                  0.53
Industry 5-yr growth rate                           19.80
GPS 5-yr LT growth rate                             20.30
GPS EPS 2001                                         1.52
GPS: Forward PEG Price                              16.47

*5 -yr LT growth rates from

Market/Book Ratio:
Company                               Current M/B Ratio

ANF                                                  6.95
AEOS                                                 4.38
IBI                                                 24.28
JWN                                                  2.21
LTD                                                  3.51
Average M/B Ratio                                    8.27
GPS Common SE                            1,573,679,000.00
GPS Shares Outstanding                     850,900,000.00
GPS Book Value/share                                 1.85
GPS: M/B Price                                     $15.29

*M/B Figures from Yahoo finance
**Common Shareholder's Equity
for GPS obtained from their latest

P/S Ratio:
Company                                  Current P/S Ratio
ANF                                                   1.62
AEOS                                                  1.34
IBI                                                   1.72
JWN                                                   0.56
LTD                                                   0.73
Average Current P/S                                 1.194
GPS Sales FYE 1/31/99                       9,054,462,000
GPS Shares Outstanding                        850,900,000
GPS Sales/Share                                     10.64
GPS: P/S Price                                      12.71
*P/S ratio's for competitors
from Yahoo Finance

Abnormal Earnings:

GPS Book Value/share                                        1.85
                                                           1999    2000 2001 2002         2003       2004      Term
Earnings                                                            1.21 1.52 1.83         2.20       2.65
Book Value(assume no dividends)                             1.85    3.06 4.58 6.41         8.61     11.25

EBO                                                         1.85   0.81    0.79    1.83   2.20       2.65
GPS EBO Price                                                                                      $27.48

Risk-free Rate                                              5.57
Beta                                                        1.22
Expected Market Return                                     13.50
RGPS                                                       0.152
*assume that after yr 5 abn earn are constant (don't
trail to zero due to intangibles)
**Risk free rate from Wall Street Journal 3.
Expected Market Return based on our own
***Assumed abnormal earnings growth 20.3%
through year 2004 and constant abnormal
earnings thereafter

DCF Analysis:
assumes CF's g= earnings growth rate                        0.25

g= 20.3%                                                   1999    2000 2001 2002 2003               2004      Term
Cash Flow/share                                             1.64    1.97 2.37 2.85 3.432              4.13
PV Discount factors                                                 0.87 0.75 0.65  0.57              0.49   PV Term
PV Cash Flows                                               1.64    1.71 1.79 1.86  1.95              2.03
PV                                                                                                 $84.97

*assume g=20.3=5-yr LT growth rate of GPS
through 2004; assume g=12.5=S&P 5-yr LT
growth rate

PESSIMISTIC: assumed g=15%                                 1999 2000       2001    2002 2003     2004          Term
Cash Flow/share                                             1.64 1.8842   2.166   2.491 2.865 3.29551
PV Discount factors                                              0.8677   0.752   0.653 0.566 0.49192        PV Term
PV Cash Flows                                               1.64 1.6349   1.631   1.628 1.624 1.62114
PV                                                                                             $68.85

*assume g=15%=5-yr LT growth rate of GPS
through 2004; assume g=12.5=S&P 5-yr LT
growth rate

OPTIMISTIC: assumed g=25%                                  1999    2000 2001 2002 2003               2004      Term
Cash Flow/share                                             1.64    2.05 2.56 3.20 4.000              5.00
PV Discount factors                                                 0.87 0.75 0.65  0.57              0.49   PV Term
PV Cash Flows                                               1.64    1.78 1.93 2.09  2.27              2.46
PV                                                                                                $101.78
*assume g=25%=5-yr LT growth rate of GPS
through 2004; assume g=12.5=S&P 5-yr LT
growth rate.


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