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Five Reasons Old Navy Must Go

Posted: Oct 22, 2008 15:44 PM by Will Ashworth

Tickers in this Article: WRC, SKS, BKE, TGT, WMT, AEO, ANF, JCG, GPS

Back in April, I wrote an article entitled "Five Reasons To Never Own Gap". The second reason on my list was Old Navy - more specifically its dismal same-store sales, which were down 27% in March. I questioned why Gap's (NYSE:GPS) management would even bother opening its doors with such numbers.

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Since that time, Old Navy has done nothing to change my tune. Its performance has been abysmal, clearly demonstrating the need for radical change; change that might be better handled by a private equity firm unencumbered by the past. Even Mickey Drexler, CEO of J. Crew (NYSE:JCG) and creator of Old Navy back when he was running the Gap, could do a better job. Not that he'd want to.

Operating Two Divisions Would Make Sense
I believe that Gap has better potential operating two divisions - Gap and Banana Republic - than it does with a third in Old Navy. Focusing on two price points rather than three would allow greater pricing flexibility in different economic environments. When times are good, like a few years ago, prices move up; when times are tough, prices move down. With Old Navy positioned below the namesake brand, it has less room to maneuver. Simply put, Gap would be smarter to spend its resources on the two original brands even if it means significantly reduced revenue. Bigger is not always better.

Here, in no particular order, are five reasons Old Navy must go:

Reason #1
Since my article in April, monthly same-store sales at Old Navy are down 12%, 25%, 10%, 16%, 9% and 24%. That’s an average monthly decline of 16% in the past six months alone. For the first half of fiscal 2008, compared to the first half of 2007, Gap’s overall same-store sales were down 11%. During the same time frame Abercrombie & Fitch (NYSE:ANF) saw a 4% decline and American Eagle's (NYSE:AEO) same-store sales went down 7%. Take out Old Navy's 17% decline in comparable-store sales, and its business doesn’t appear nearly as broken.

Reason #2
For the 26 weeks ended August 2, Old Navy's net sales dropped $407 million or 13%. If not for the 18.1% increase in the discount brand's online sales, the drop would have been greater. This compares unfavorably with the rest of the business, which was flat or increasing slightly. Gap management should send Old Navy out to sea, never to be seen again. Without the anchor around its neck, Gap would be far more profitable.

Reason #3
Another important number when examining retail companies is sales per square foot. The higher the better; for instance, Wal-Mart’s (NYSE:WMT) are greater than $400 per square foot, which compares favorably with Old Navy ($312) and Gap ($402) but far less than Banana Republic’s $540. While sales per square foot are critical, so too are operating profits. It matters little if these sales don't translate into profits. I believe that Old Navy will continue to lose business to discount retailers like Wal-Mart who are working to improve apparel quality and selection. (For more analysis on numbers like this, read Analyzing Retail Stocks.)

Reason #4
Old Navy has more than 20 million square feet under lease - more than Gap and Banana Republic combined. The company as a whole has $4 billion in lease commitments through 2012. Selling Old Navy would significantly reduce its rental payments going forward with the savings plowed back into improving each of the remaining brands. Howard Davidowitz, a retail consultant, investment banker, chairman and sole stockholder at Davidowitz & Associates, believes Old Navy's early 2008 plans to spruce up to compete with retailers like H&M, Zara and even Target (NYSE:TGT) likely won't work. That's because Old Navy isn't addressing the big problem - stores that are way too big. The typical Old Navy averages 19,000 square feet - almost four times as big as the average Buckle (NYSE:BKE) store, which in my opinion is the best-operated specialty retailer in America.

Reason #5
In February, Gap moved out Old Navy President Dawn Robertson and temporarily replaced her with its outlet president, Tom Wyatt. Wyatt's retail history includes stints at Saks (NYSE:SKS) and Warnaco (NYSE:WRC). In late August, CEO Glenn Murphy made the move permanent. Wyatt must have made a good impression. Unfortunately, little evidence indicates that Gap has done anything except shuffle the deck chairs. Can you say "Titanic"?

Bottom Line
I’ve never been a fan of Gap, as my April article would attest. However, if it was able to get a decent price for Old Navy, I might be convinced to change my mind.

Learn more about how to dissect retailers by reading The Industry Handbook: The Retailing Industry.)

By Will Ashworth

Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.

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