Gap, Inc. (GPS): Wells Fargo is Warming Up, Raising PT But Not Rating Yet

Wells Fargo analyst, Ike Boruchow, maintained his Market Perform rating on Gap, Inc. (NYSE: GPS) but this morning's note had a very constructive tone. The analyst believes that GPS continues to be a consensus underweight on the buyside–shares have rallied nearly 40% since mid-May (vs. SPX +6%) and we actually see a more favorable near-term setup on the horizon.

The fact is, GPS has several structural hurdles that remain longer-term issues in our view (over stored, apparel deflation, increased fast fashion competition), but with that said, as we move into 2H, investors are going to need to find a handful of contrarian names that have the opportunity to produce meaningful multiple expansion in a potential “rising tide” environment (well owned names like COH, LULU, ULTA, NKE, TJX, ROST, BURL, CRI are all near peak valuations today). With that said, several interesting developments of late seem to create a more favorable situation for GPS, including:

1) in June it put up its first positive comp in 15 months

2) when it reports July sales (a fairly immaterial piece of Q2) we expect management to guide Q2 EPS above the Street (potentially $0.53-$0.55 vs. Street’s $0.48)

3) Old Navy (ON) is just 3 months away from lapping meaningfully easier comparisons from LY (when Stefan Larsson resigned and business turned negative)

4) the company recently laid out $275 million of cost savings for next FY (or $0.40-$0.50 in EPS) which drives a good deal of cushion to out-year earnings estimates (our $2.24 estimate is well above the Street’s $2.04)

5) GPS remains one of the cheapest names in our group (5.0x EV/EBITDA and 11.0x P/E on 2017 numbers) with some of the most negative sentiment in the space despite some recent positive data points.

All in, the analyst is raising FY16/FY17 estimates to $1.90/$2.24 (from $1.88/$2.22) and the valuation range to $25-$27 (from $20-$22) – and with the first positive EPS revision in roughly 18 months looming, the analyst doesn't see this recent rally ending in the near-term.

He is also raising the valuation range roughly 25% to $25-$27 (from $20-$22).

For an analyst ratings summary and ratings history on Gap, Inc. click here. For more ratings news on Gap, Inc. click here.

Shares of Gap, Inc. closed at $24.34 yesterday.

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