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Gap is undervalued with a 'powerhouse' in Old Navy, analyst says

Key Points
  • Jefferies has named apparel retailer Gap one of its top "Franchise Picks"
  • Analyst Randal Konik assigned the stock a buy rating with a higher price target of $39 per share, up from $35
  • Gap shares closed Monday at $27.61, up more than 6.4 percent
A customer lifts a shopping bag at an Old Navy store in San Francisco.
David Paul Morris | Bloomberg | Getty Images

Wall Street largely underestimates Gap's growth potential, one analyst said Tuesday, claiming Old Navy offers enough of a reason to bet big on the apparel retailer.

Jefferies has named Gap one of its top "Franchise Picks," pegging the stock with a buy rating and a higher price target of $39 per share, up from $35. Gap's stock closed Tuesday at $27.61, up nearly 6.5 percent.

Last week, Gap said it will be shifting its strategy to focus on its two "growth brands" — its cost-conscious Old Navy business and its athletic apparel lines within Athleta. The retailer has also offered up its first look at its divisions' margins.

After crunching the numbers, Konik said, the Old Navy nameplate is generating nearly three-fourths of its parent company's profits. With that growth, Old Navy is well on its way to hitting 80 percent of earnings in a few years, he added.

"Old Navy continues to exhibit positive data results from our webscrapes," Konik explained. "This makes us incrementally more confident about top-line trends. We believe this data, coupled with our store checks, suggests continued momentum for Old Navy ahead."

GPS operating margins by division, for 2017

Source: Jefferies

For now, Gap's stock is being valued for its Gap business alone, and that makes the stock a "mispriced asset," Konik wrote in a note to clients.

Meantime, Athleta is gaining a larger share of the athletic apparel market, Konik said, applauding Gap's push in this separate division. Peers in the athletic space include Lululemon, Nike and Adidas. And some of Old Navy's biggest off-price competitors consist of TJX, Ross and Burlington.

Gap CEO Art Peck said last week the company expects net sales at Old Navy to exceed $10 billion, and sales at Athleta to top $1 billion during the next "few years."

These gains will come as a result of U.S. store expansion efforts and growth in e-commerce and mobile, Gap said. The company will be shuttering 200 Gap and Banana Republic locations, while simultaneously opening nearly 300 Old Navy, Athleta and what Gap calls "value expression" shops.

Konik added that Old Navy's fleet of stores is especially appealing since they're typically detached from malls. In Athleta, Konik expects the brand to continue to be a "share gainer in an attractive athletic apparel category."

As of Monday's close, Gap shares have rallied more than 15 percent higher over the past year.

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