Gap Stock (NYSE: GPS) Jumps on Upgrade

What a first half of the year it’s been for retail. The higher-end names were already struggling to remain competitive with the discount department stores before COVID-19 hit. The pandemic shuttered their doors overnight and made their premium products both unattractive and unattainable for many as consumers tightened their belts.

Despite also taking an initial hit in the risk-off sentiment that had investors fleeing from equity markets, the cloud-heavy tech industry could be said to have thrived for a finish, with many names, both big and small, breaking to all-time highs consistently in recent weeks. But many retailers can’t make the same boast.

As the initial round of restrictions has been rolled back, other industries like travel and hospitality have seen strong bids but most of the retailers have languished, barely off their March lows. Some discount names, like ROSS (NASDAQ: ROST) and Target (NYSE: TGT), have already undone most of Q1’s damage but others like Gap (NYSE: GPS) only hit their lows in April or May and are still struggling.

Double Notch Move

There was some fresh and much-needed optimism in Gap shares however on Monday when Wells Fargo came out of the gates strong to start the week with a fresh Overweight rating on the stock. This was particularly notable because going into the weekend, Wells Fargo’s most recent rating for Gap was Underweight, meaning they’ve completely skipped the Neutral step in between. This bullish move was enough to send Gap shares up more than 8% during Monday’s session and within just a few percent of their post-crash highs.

In a note to clients, Wells Fargo said "at a high-level, we believe the company’s fundamental struggles are now well-appreciated by the market, but there are two compelling value unlocks we see as under-appreciated. 1) In conjunction with GPS’s recent ABL debt transaction, the company disclosed real estate value of $1.9B (San Fran HQ, 4 DCs). 2) Athleta (the highest margin and fastest growing concept in the portfolio) is underappreciated; even though athleisure has clearly accelerated due to the pandemic, this has not translated into a value appreciation for the Athleta brand within GPS.”

It looks as if they’ve unlocked some fresh value in the beaten-down high street retailer and unsurprisingly, Wall Street has taken notice. Even with Monday’s jump, shares are still about 60% away from the fresh price target of $19 so there’s plenty of room to go for investors thinking about getting involved. Considering Gap’s stock is down around 70% from last year’s high, it’s fair to say that most of the downside is already priced in.

Not All Rosy

That’s not to say that there are only good times ahead. The company’s Q1 earnings report at the start of June painted a grim picture, with revenue down 43% year on year. Their EPS number was also firmly in the red, way below what analysts were expecting, albeit coming after one of the most unpredicted and unpredictable quarters in history. Gap is also in the middle of a lawsuit with the landlord of many of their rented stores, Simon Property (NYSE: SPG), who has sued them for $65 million in unpaid rent.

The pessimist might stay well enough clear of a name like this, but the optimist might consider that most of this negativity is already priced in and the upside far outweighs the downside at current prices. As often happens on the street, when one firm comes out with a surprise upgrade on a stock, it causes the others to take a closer look themselves and to issue a fresh rating, if only to remain relative and in the news.

With Gap shares trading up 120% from the lows of April, let’s see if they can keep the momentum going and if the good news can keep flowing in.