Did The Gap's Fundamentals Just Reach An Inflection Point?

The market may not be buying Gap Inc GPS’s Q3 earnings report, but Jefferies is. Analyst Randal Konic has reiterated the firm’s Buy rating on the stock following a 15.2 percent Friday selloff.

Despite disappointing Q4 guidance, he sees positive fundamental changes happening at Gap. According to Konic, Q3 may have marked an inflection point for Gap’s business.

“While we acknowledge the headwinds in 4Q, we see guidance as conservative and expect the gradual improvement to continue, further supported by the implementation of cost reductions,” he explained.

Thesis

Jefferies bullish thesis on Gap is driven by four factors:

1. Inflecting cash flows.
2. Old Navy’s fast fashion exposure.
3. The Gap brands continuing relevance.
4. Strategic moves that enhance shareholder value.

Analyst's Take

In the near term, Konic sees easier comps ahead in the next several quarters as well.

Inventory levels fell 4 percent in Q3, and the company’s plan to keep inventory levels tight should also boost margins. In addition, Konic estimates that the Gap’s target of $275 million in cost savings in fiscal 2018 will add another 2 percent to margins.

While other analysts are lowering price targets for the stock, Jefferies has upped its target from $32 to $36.

Despite Friday’s selloff, Gap stock remains up 4.7 percent in 2016. At last check, Gap shares were down 16.51 percent at $25.64.