Stifel affirms Gap, Inc. (NYSE: GPS) at Buy with a price target of $40 following the clothier's Q2 report on Thursday night.

Analyst Richard Jaffe noted that EPS of $0.64 was flat with recently established guidance. The analyst commented, Foreign exchange had a negative 5% impact on EPS. While GPS remains a well-controlled and well managed business, the merchandising challenge facing Gap division continues to compromise results despite outperformance at Old Navy. The less-than-appealing merchandise assortment at Gap division continues to be a drag on GPS earnings. While results will be challenging in the near term, longer term the company has significant opportunity for improvement.

General commentary: Art Peck and his senior managers have committed significant resources to refining the Gap brand’s organization; modeling it on Old Navy’s highly successful sourcing, merchandising and marketing model. Unquestionably, we believe this is the right thing to do given Old Navy’s exceptional success. The challenges are 1) adapting the Old Navy model to suit the higher-priced Gap brand 2) successfully and consistently executing to that strategy and most importantly 3) having consumers cross the threshold of Gap stores this Spring and spend. The people are in place, the resources are there and the investment community (buoyed by Old Navy’s remarkable consistency) is giving them the time to get it right. We are convinced that GPS can manage through a challenging 2H, with Old Navy carrying an underperforming Gap division. However, it is 1Q:16 when the likelihood of a turnaround at the Gap division will become clear.

On Jaffe's Buy rating: Management’s investments in an omnichannel shopping experience and international stores provide visibility for continued growth as the rate of improvement of the core businesses slow. However, given the recent leadership changes and weakness at Gap brand, the investment has become more speculative and necessarily longer term.

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