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Greenberg: Gap Stock Downgraded—Time Running out for Investors?

To see two analysts downgrade shares Gap today makes you wonder what they know and investors don’t

Or, based on the performance of Gap’s stock, what investors knew and the analysts didn’t — until now?

Either way, it doesn’t matter. These two reports — one from Bank of America Merrill Lynch and the other from Goldman Sachs— don't mince words.

And the Goldman downgrade to the dreaded “sell” by analyst Michelle Tan, was (like much of what she does) devastatingly blunt.

Weakness the Norm

Among Tan’s comments:

- Gap’s relative sale weakness over the past two months will prove to be the norm, resulting in further earnings per share weakness.

- Gap’s comp-store sales have declined, on average, by 4 percent a year over the past 10 years. After an 18-month improvement, she expects “a reversion” to weaker trends.

- Gross margins are likely to face pressure as inventory builds.

“Bottom line,” Tan wrote, “we believe the relative sales weakness of the past two months is not an anomaly, but more representative of the trend going forward. Essentially, we believe that GPS is subject to long-term share loss as a result of their broad footprint and increasing pressure from more focused competition.”

Do or Die Time?

Which raises the question: Is time running out for the retailer — or for investors in Gap’s stock?

Gap’ stock has been a good, bad or indifferent investment, depending on the time period. Over the past five years it has beaten the S&P 500, thanks largely to a brief period in 2009 when, for a brief moment, it appeared the company was getting its act together.

But over the past two years Gap’s stock has merely tracked the index. And over the past year and year-to-date it has been a laggard — even with a boost it got earlier this year, when a hedge fund run by Sears Chairman Eddie Lampert bought 5.8% of Gap’s stock.

Is Gap Fixable?

The issue for investors is whether Gap can be fixed.

When Gap was in its prime in the 1998 to 2002 time frame, there was one big difference: It didn’t have breadth of competitors — from the likes of H&M and Abercrombie & Fitch to Aeropostale and Spain’s Zara.

“Over the past 10 years all of those companies in some shape or form have come on the scene in a very strong way,” says John Long, a retail strategist at Kurt Salmon, who has advised Gap in the past.

“There are now so many specialty apparel stores that reside in the Gap space. They really have to address that fundamentally to succeed. To some degree they haven’t embraced how difficult the competitive landscape is.”

To fix itself, Long says the company “has to completely redefine itself; the space they owned 10 years ago doesn’t exist anymore.”

The company tried to do that under Paul Pressler, Gap’s CEO from 2002 to 2007, as he focused on a complete revamp of the company’s signature Gap brand. But that didn’t take hold, and “the benefit of merchandising fixes at Old Navy are fading,” says Tan.

Also missing, observers say, is what would appear to be a sense of urgency at the company — especially among rank-and-file at the corporate headquarters.

But is this do or die? “I thought so a few years ago,” Long says. “But they’re always resilient, like the Lazarus from the ashes. They always seem to pull rabbits out of the hat at the last minute. They’ve been continually able to do something like that to get people energized.

"But you have to wonder how many lives they get.”

If you’re a Gap investor — indeed you do.

Questions? Comments? Write to HerbOnTheStreet@cnbc.com

Follow Herb on Twitter: @herbgreenberg

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CNBC Data Pages:

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Disclosures:

Disclosure information was not available for Tan, Long or their companies.

Disclaimer

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