Gap Inc.’s decision to split Old Navy into its own company is being cheered by experts, analysts and investors who think this portfolio star will now be able to shine more brightly.
The news sent shares up more than 18% in Friday trading, and has onlookers optimistic about the prospects for Old Navy.
“The fate of Old Navy is now not tied to the fate of Gap,” said Jonathan Treiber, chief executive of offer-management platform RevTrax.
“The key motivation here isn’t about the Gap but rather to ensure that the success of Old Navy won’t continue to be overshadowed and weighed down by the sluggishness of Gap performance. By splitting the businesses out, Old Navy has the best opportunity to thrive and deliver value to shareholders without Gap dragging down combined performance.”
Read: Gap to spin off Old Navy as stand-alone company, stock skyrockets more than 25%
On the earnings call, Gap Chief Executive Art Peck discussed the ways in which the different names under the Gap Inc. GPS, +18.37% umbrella have traveled different paths. Though the company has taken a multiplatform approach to all of its brands, some have thrived while others have languished.
“Old Navy’s value creation levers, business model, and customers have increasingly diverged from our specialty brands,” he said, according to a FactSet transcript. “That divergence to me is now clear. And we think the best way for each company to grow and meet the evolving needs of our customers is to allow them to pursue tailored strategies separately.”
Many details about the split are still to be worked out, with the separation transaction expected to be complete in 2020. The company has said that 230 Gap stores will close over the next two years. At the beginning of 2018, Gap specialty stores totaled 725 around the world. Sixty-eight stores closed during the year. In addition, there will be closures as leases expire after 2020.
“Old Navy is one of the most attractive concepts in apparel retail,” wrote KeyBanc Capital Markets analysts led by Edward Yruma. “The banner has consistently had some of the strongest comps in our coverage and we think that its positioning of bringing value and fashion to a family consumer is an important differentiator.”
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Old Navy as a stand-alone company, which will continue to be led by Sonia Syngal, will have about $8 billion in annual revenue.
“We are also increasingly confident that Old Navy can execute a small box strategy in an effort to accelerate unit rollout,” said KeyBanc.
KeyBanc rates Gap Inc. shares sector weight.
Others expressed more concern about the impact of the split. While MKM Partners analysts think it is “a positive strategic development to unlock value for shareholders,” there could be drawbacks.
“We aren’t yet convinced that this is the right move from a corporate standpoint, or that Old Navy will be better served as a separate entity,” MKM Managing Director Roxanne Meyer wrote. “There are also questions around the extent of dis-synergies (no longer leveraging a tri-branded credit card, web platform, supply chain, real estate, etc.) and the impact on sales.”
MKM rates Gap Inc. shares neutral with a fair value estimate of $33, up from $30 previously.
Both MKM and KeyBanc think the newly formed “NewCo” has an underrated gem: Athleta.
“In our view, there is more strategic rationale to spin out Athleta than Old Navy, but perhaps the timing isn’t quite right for Athleta,” Meyer wrote.
Among her reasons, she said Athleta has a higher-end, more differentiated customer; uses more expensive fabrics that are probably from distinct sources; and has the highest earnings growth and highest same-store sales of the brands. Gap’s Peck said on the call that both Athleta and Old Navy continue to gain market share.
However, Athleta is still scaling up its girls business and is building its men’s business.
Among the other “NewCo” brands, there is much to do. Besides closing Gap stores, there’s still the lingering issues with Banana Republic, which though much improved, still reported a 1% same-store sales decline in the fourth quarter. While the brand is working on getting promotions under control, which resulted in margin expansion in the fourth quarter, it also hurt traffic during the quarter.
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As for the namesake brand, we could end up with a Gap that doesn’t look like the one we’ve come to know.
“[I]t could be the end of Gap as we know it as it will likely need to undergo some significant changes to appeal to relevant shopper groups,” said Tiffany Hogan, senior analyst specializing in apparel and beauty for Kantar Consulting. “Whatever success looks like for them will be based on how they redefine their target audience and how well they go about connecting with them through more than just products.”
That could include in the area of sustainability, which Peck said on the call would be a focus of “Newco.”
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“It’s all about what it does next. Gap needs a head-to-toe makeover,” said Hugh Tallents, partner at management consulting firm cg42. “That means an overhauled design, better distribution mix, and a clear sense of identity it hasn’t had since the ‘90s. The danger is that management focuses too much on the shareholder brand, ‘NewCo,’ without fixing the pieces that live underneath it.”
Gap shares are up 16.4% for the year so far, though down 5.4% for the last 12 months. The SPDR S&P Retail ETF XRT, +0.74% has rallied nearly 12.6% for the year to date, and the S&P 500 index SPX, +0.50% as gained 11.5%.
