Buy Gap While You Can Still Lock In The 8% Yield

Gap, A Virus-Proof Retail Stock?

If you are thinking I have to be crazy to recommend a retail stock like Gap (GPS) at a time like this you may be right. The coronavirus scare has the market in fear of recession and that is no time to buy retail. If you rethink the situation, however, you may come up with a different opinion. I want you to think about Gap from a different perspective. I want you to think about Gap as a company emerging from turnaround efforts that have it set up for growth in 2020.

The virus may have an impact on earnings this year but, according to what management is telling us, that impact isn’t going to impair the company’s return to growth or ability to pay the dividend.

Factors like slowing mall traffic, the shift to eCommerce, fickle consumer tastes, and declining revenue had shares of Gap down more than 60% and at rock bottom prices before the virus set in. Now, with turnaround efforts taking hold and after the viral-induced selloff, shares of Gap are trading at their lowest level in over ten years.

CEO Sonia Syngal

“During our 50-year history, Gap, Inc. has weathered many storms. We will benefit from our strong balance sheet and cash generation as well as our important vendor relationships during this current challenging period. We are focusing on decisive actions that will ensure we emerge well-positioned to compete in the years ahead, and I am impressed by how diligently the teams have navigated the events of the past weeks”

The Dividend Is Sound

While Gap hasn’t increased its dividend in two years it does have a solid history of dividend increases. In fact, even during its darkest times, the company has never cut the distribution that I am aware of. At today’s prices the yield is well above 8.0% and as safe as it has ever been. The company’s payout ratio is at the high-end of the range I like to target, nearly 60%, but it is still at manageable levels so a distribution cut really isn't on the table. Considering the company is on track to resume growth this year the odds favor another distribution increase.

The Winds of Change

Over the last handful of quarters, Gap has been working on a rationalization intended to reduce costs, streamline operations, and unlock shareholder value. Those efforts put the company in a lean operating position ahead of the virus which, it turns out, is good positioning for the outbreak. You don’t have to look for ways to cut costs and save money if you’ve just completed a thorough business rationalization.

Part of the rationalization includes a change of management that is already in effect. Long-time CEO Art Peck stepped down from his position last fall including his spot on the board. Mr. Peck is followed by Old Navy chief Sonia Syngal and several members of her team. Syngal was CEO of Old Navy since 2016 and comes with decades of experience in the retail industry.

Fourth Quarter Results And 2020 Guidance Are Good

The fourth-quarter results were released today and they are good. Results are better than expected on the top and bottom lines despite negative comps. Comps fell -1.0% across the footprint but the figure doesn’t tell the whole story. Negative comps in the Gap-branded stores fell -5.0%, less than expected, while comps at Old Navy and Banana Republic were flat and Athleta rose 1.0%. Weak comps at Old Navy are still a concern but better than expected and show turn around efforts are taking hold.

The weakness in comps is offset by an increase in margin, 70 basis points at the gross level, that helped drive a profit beat. Looking forward, the company is expecting full-year results to improve in both fiscal 2020 and 2021 with EPS gains outpacing revnue. Revenue growth is not expected to be robust, far from it at roughly 0.2% annually, but EPS growth should outpace that by 300 to 400 basis points.

The company is expecting EPS in the range of $1.80 to $1.92 versus the consensus of $1.68. This opens the doors to a round of analysts upgrades that could help support share prices in the coming quarters. The average analyst’s target is a hold with 12 of 18 analysts rating a neutral or hold so there is plenty of ammunition in that gun.

The Technical Outlook: Reversal At Hand

While it is too early to call a reversal in this stock it looks like one could be forming. Price action over the last few days suggests capitulation within the broader market and Gap specifically. The last two candles, notably, look like a bearish Shooting Start-turned Abandoned Baby. The Shooting Star shows a trend about to change, the Abandoned Baby a trend reversed. The caveat, of course, is that a trend changed or reversed doesn’t mean from down to up, it could mean from down to sideways until the viral threat has passed.