. 104
( 208 .)



The Gap
In their 1991 Letter to Shareholders, President Drexler and CEO Fisher described The
Gap™s outlook as follows:
Our challenges for 1992 and beyond begin with increasing market share through
continued sales growth. To start working toward this goal we will open approxi-
mately 135 new stores in 1992. We will also continue the program to expand our
locations by enlarging approximately 100 existing stores.
Along with building new stores and larger stores, . . . we plan to continue to
grow our business through a concerted effort to increase consumer awareness of
our four brands”Gap, GapKids, babyGap, and Banana Republic.
The Gap has stated goals of at least 20 percent annual sales and EPS growth; 30 per-
cent ROE; and pretax margins of 10.5 to 11 percent. The growth is to be supported
through capital expenditures of over $200 million per year beyond 1992.11 In the fore-
seeable future, most of this will be devoted to investment in the U.S. However, interna-
tional sales may become increasingly important. By the end of 1993, The Gap expects
to have approximately 100 stores outside the U.S., primarily in Canada, but with an in-
creasing presence in the U.K. Longer term, there is some possibility of expansion to Eu-
rope and Asia.
Analyst Michael Schiffman rated The Gap a strong buy, based on his optimism about
short-run earnings performance, but still expressed some reasons to constrain enthusi-
asm about the long run:
The Gap has been a big bene¬ciary of changes in spending habits in the 1990s.
Recessionary times have altered consumers™ attitudes over the last couple of
years. Expensive, impressive “labels” are out; value is in. . . . In the current envi-
ronment, consumers have decided that a logo is not worth the extra cost.

8. Fortune, December 2, 1991, p. 106.
9. Business Week, March 9, 1992, p. 60.

10. Fortune, op. cit.
11. Duff and Phelps Company Analysis (April 1992).
Prospective Analysis: Valuation Implementation

12-29 Part 2 Business Analysis and Valuation Tools

Will these changes be long-lasting? That remains to be seen. It™s not clear to
us that people™s attitudes have been permanently altered; that when prosperity re-
turns, they will still flock to this retailer™s stores in search of good quality at a val-
ue price. That™s not to say the market for good-quality apparel at prices most
people can afford to pay will disappear. We just don™t think it will continue to
grow by leaps and bounds over the next 3 to 5 years.12
Analyst Carol Palmer was more optimistic:
. . . The big question is whether The Gap can continue its recent record of success;
more precisely, is its formula one for this recession (in which white-collar
boomers are tightening their belts) or one for the decade of the ™90s?
The market™s worst fear about The Gap appears to be that, in an economic re-
covery, shoppers will trade up from The Gap for casual wear. In our opinion, con-
sumers will merely complement Gap-shopping with more traditionally upscale
The Gap

shopping as they sense themselves gaining purchasing power. We think a better
economy should serve to bolster The Gap™s formidable consumer franchise.13

1. The Gap™s return on equity for fiscal 1991 was extraordinarily high. Analyze the
company™s profitability, relative to prior years and relative to the competition. Which
components of profitability provided the Gap with its “edge” in 1991? What appear
to be the sources of that edge, and what does that suggest about The Gap™s business
strategy? What is your assessment of the sustainability of the company™s profita-
2. Forecast earnings and cash flows for The Gap for fiscal 1992.
3. With its stock price standing at $55 per share in early 1992, what must the market
have in mind for The Gap? Using a valuation model”based either on discounted
cash flow or discounted abnormal earnings”infer what possible combinations of
profitability, growth, and cost of capital would be necessary to justify such a price.
4. Compare your assessment of prospects for profitability at The Gap with those reflect-
ed in the market price.

12. Value Line report (February 28, 1992).
13. Duff and Phelps Company Analysis (April 1992).
490 Prospective Analysis: Valuation Implementation

Prospective Analysis: Valuation Implementation

Excerpts from The Gap™s 1991 Annual Report


Operating expenses as a percentage of net sales
Net Sales were 22.9%, 23.4% and 22.9% for ¬scal years
1991,1990 and 1989. The .5% decrease in 1991
Fiscal Year Ended from 1990 was primarily due to lower payroll costs
as a percentage of net sales, which re¬‚ected the
Feb. 1, 1992 Feb. 2, 1991 Feb. 3, 1990
positive leverage achieved on expenses through
(Fiscal 1991) (Fiscal 1990) (Fiscal 1989)
52 Weeks 52 Weeks 53 Weeks
sales growth. The .5% increase in 1990 from 1989

The Gap
was largely attributable to costs associated with the
Net Sales ($000) $2,518,893 $1,933,780 $1,586,596
Total sales growth 30% 22% 27% write off of ¬xed assets for store expansions and
Growth in compar-
able store sales
(52-week basis) 13% 14% 15%
Net Interest Expense
Number of
New stores 139 152 98
Net interest expense was $3,523,000 and
Expanded stores 79 56 7
$1,435,000 and $2,760,000 for ¬scal years 1991,
Closed stores 15 20 38
1990 and 1989. The increase in 1991 over 1990 of
$2,088,000 was due to increases in average net
The opening of new stores (less the effect of stores borrowings and average net interest rates. The
closed), and the expansion of existing stores, as well decrease in 1990 from 1989 of $1,325,000
as the increase in comparable store sales con- re¬‚ected lower average net borrowings and lower
tributed to total sales growth for the ¬scal years average net interest rates.
1991, 1990 and 1989.
Hemisphere Closure
Net sales per average square foot increased to
$481 in 1991 from $438 in 1990 and $389 in During the fourth quarter of 1989, the Company
1989. Over the past two years, the Company has closed its Hemisphere stores resulting in a pretax
increased the average size of its new stores and charge to earnings of $10,785,000 ($.05 per share
expanded the size of some of its existing stores. This after tax). This charge represented the write down of
has resulted in a net increase in total square footage related property and equipment, inventory, fourth
of 18% in 1991 and 17% in 1990. quarter operating loss and a provision for occu-
pancy expenses.
Cost of Goods Sold and Occupancy Expenses
Income Taxes
Cost of goods sold and occupancy expenses
decreased as a percentage of net sales to 62.3% in The effective tax rate was 38.0% in 1991 compared
1991 from 64.2% in 1990 and 65.9% in 1989. The with 39.0% in 1990 and 40.0% in 1989. The 1.0%
1.9% decrease in 1991 was primarily a result of an decrease in the effective tax rate for 1991 was pri-
increase in merchandise margins as a percentage of marily due to a reduction in state taxes and net for-
net sales. The 1.7% decrease in 1990 was the result eign taxes as a percentage of earnings before
of higher merchandise margins, somewhat offset by income taxes. The 1.0% decrease in 1990 was pri-
an increase in occupancy expenses as a percentage marily due to a reduction in state taxes as a percent-
of net sales. age of earnings before income taxes.
Prospective Analysis: Valuation Implementation

12-31 Part 2 Business Analysis and Valuation Tools

LIQUIDITY AND CAPITAL RESOURCES certain existing stores. Planned expenditures also
include costs for administrative facilities and equip-
The following sets forth certain measures of the ment. The Company expects to fund such capital
Company™s liquidity: expenditures by a combination of anticipated cash
¬‚ow from operations, normal trade credit arrange-
Fiscal Year ments, and bank and other borrowings. New stores
are generally expected to be leased.
1991 1990 1989

In February 1991, the Company issued $75
Cash provided by operat-
ing activities ($000) $333,696 $256,892 $118,093 million of 8.87% Senior Notes which are due in Feb-
Working capital ($000) $235,537 $101,518 $129,139
ruary 1995. Interest is payable quarterly. The Senior
Current ratio 1.71:1 1.39:1 1.69:1
Notes are redeemable, in whole or in part, at any
Debt to equity ratio .12:1 .04:1 .06:1
time after February 22, 1993, at the option of the
In 1991, capital expenditures totaled $227 million,
The Company has a credit agreement which
net of construction allowances and dispositions (rep-
provides for a $250 million revolving credit facility
resenting the addition of 139 new stores, the expan-
The Gap

until March 1995, at which time any outstanding
sion of 79 stores and the remodeling of certain
borrowings can be converted to a four-year term
existing stores) which resulted in a net increase in
loan. In addition, the credit agreement provides for
store space of 876,100 square feet. The expendi-
the issuance of letters of credit during the three-year
tures also included the construction of the Maryland
revolving period for up to $300 million at any one
distribution facility and an offsite data center. Capi-
tal expenditures were $200 million in 1990 and $94
million in 1989, a net increase in store space of Under the Company™s 1988 program to repur-
705,700 square feet in 1990 and 177,300 square chase up to 12,000,000 shares of its common
feet in 1989. stock, 40,460 shares were repurchased in 1991 for
In ¬scal year 1992, the Company expects capi- $1,004,000. To date, 10,484,528 shares have
tal expenditures to total approximately $230 million, been repurchased for $92,454,000. Share amounts
net of construction allowances, representing the have been restated to re¬‚ect the two-for-one splits of
addition of approximately 135 stores, the expansion common stock to stockholders of record on June 17,
of approximately 100 stores, and the remodeling of 1991 and September 17, 1990.

Market Prices(a) Cash Dividends(a)

Fiscal 1991 1990 1991 1990

High Low High Low

$311„2 $173„8 $125„32
1st Quarter $20 $.062 $.048
361„8 203„16 173„8 1321„32
2nd Quarter .080 .048
471„2 343„4 141„32 103„32
3rd Quarter .080 .062
443„4 211„4 131„4
4th Quarter 59 .080 .062

Year $.302 $.22

The principal markets on which the Company™s stock is traded are the New York and Paci¬c Stock
Exchanges. The number of holders of record of the Company™s common stock as of April 3, 1992 was
(a) Restated to reflect the 2-for-1 splits of common stock to stockholders of record on June 17, 1991 and September 17, 1990.
492 Prospective Analysis: Valuation Implementation

Prospective Analysis: Valuation Implementation


($000 except per share Fiscal 1991 Fiscal 1990 Fiscal 1989
amounts) 52 Weeks 52 Weeks 53 Weeks

Net sales $2,518,893 100.0% $1,933,780 100.0% $1,586,596 100.0%
Costs and expenses
Cost of goods sold and


. 104
( 208 .)