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Is Gap Too Big to Succeed?

Gap has been in a "turnaround" mode for years, yet its strategies have yet to take hold.

Gap jeans
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Gap jeans

The company reports after the bell Thursday, and on average analysts expect the company to earn 39 cents a share. That's down 13 percent from last year.

What's worse, some analysts expect the retailer will lower its 2011 earnings target when it announces its results. These people suspect Gap has been hurt by reduced sales in Japan in the wake of the earthquake and tsunami and by margin pressure as they work to clear excess inventory in the first half of the year.

Gap's decade-long problems go beyond its merchandise mix, though that remains an issue, especially at its core Gap stores. The retailer also needs to work on its marketing message at its Old Navy stores and rethink the number of stores it operates, according to some analysts.

Still, there are opportunities for growth. Gap's domestic brick-and-mortar operations are quite mature, yet internationally, Gap is quite small. The retailer opened its first locations in China and Italy just last year. Yet three of its four stores in China are in the top 5 percent of the fleet in terms of total sales volumes.

Gap plans to open 12 to 15 more stores in China this year, and with just 55 percent brand awareness in China, some analysts expect there's huge opportunity for further expansion in the country as the brands have been well received so far.

Still, it's not a sure thing. JPMorgan specialty retail analyst Brian Tunick said Gap comes against highly desired "logo-ed" competition in international markets from rivals like Abercrombie & Fitch and Ralph Lauren .

Gap's franchise arm is seen as the largest driver of its international growth. The company plans to add 75 international franchise locations around the world to the current 178. At the company's annual shareholder meeting in February, Gap management pointed out existing countries are only 30 percent penetrated.

Gap's highest-margin segment is its e-commerce business. In addition to adding brick-and-mortar stores overseas, Gap is also in talks to launch websites.

Gap's online-only Piperlime unit and its mostly-online Athleta business have grown 150 percent on average over the past five years.

Tunick says these sites compete with sites such as Amazon.com's Zappos.com and Lululemon.

But at its core business, Gap may simply be too big to succeed.

"It's very tough to create newness, to really be on point on fashion, when you are 2.5- to 3-times as big as an average specialty retailer," Tunick explains.

Gap has found that as it reduces the size of Old Navy stores, and closes some of its Gap locations, its return on invested capital increases.

The retailer has a lot of ground to regain. Of the 26 specialty retailers JPMorgan tracks, Gap's brands—Gap, Banana Republic, and Old Navy—have lost the most market share compared with its competitors since 2003.

Forever21, Urban Outfitters , Aeropostale, H&M and Abercrombie & Fitch have picked up customers who are turning away from Gap.

Gap's stock price also has been under pressure for some time. Tunick points out the retailer has been aggressively buying back stock. Gap has repurchased 45 percent of its outstanding shares since 2003. (Currently, the Fisher family and Eddie Lampert's ESL Partners own 30 percent of Gap's outstanding stock.)

"Gap will be competing to buy back stock over the next few years against an increasingly shrinking float so that alone should provide some upward bias to Gap’s stock price, and of course, allow the company’s earnings per share to hang in there, even if same-store sales domestically are negative and they have additional margin pressures," Tunick says. "It rewards shareholders, and it also allows the earnings per share to be cushioned even in times of volatility as we’re seeing this year."

Questions? Comments? Email us at consumernation@cnbc.com.

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