Morgan Stanley Downgrades Gap To Underweight Amid 'Structural Weaknesses'

Morgan Stanley’s Kimberly C Greenberger downgraded the rating for Gap Inc GPS from Equal-weight to Underweight, with a price target of $26. Although fundamentals continue to be weak, Gap’s shares have outperformed the group since mid-February.

While fundamental challenges persistent, Gap’s shares have rallied 25 percent since mid-February, versus an average 20 percent gain for Morgan Stanley’s coverage universe. Analyst Kimberly Greenberger believes that the company’s value proposition is not competitive, as two of its main brands - Banana Republic and Gap – have “lost relevance with consumers.”

The fixes required will take time to execute and Gap is likely to continue losing share, Greenberger pointed out. While Gap may at times be able to generate "less bad" results, it may not be able to overcome structural headwinds over a 12 to 24 months, adversely impacting sales, margins, and the company’s shares.

No Support For EPS

Share buybacks have contributed 9 percent to Gap’s annual EPS growth since 2011. “But 2015's $361M net debt, ~3.2xadj. leverage, and $400M October 2016 term loan maturity likely limit buybacks to ~$400-$450M annually through 2018 (vs. 5-year average $1.3B),” the analyst commented.

Moreover, having captures significant savings over the past few years, cost cuts may begin to plateau soon. Meanwhile there is little hope of structural margin headwinds, such as wage inflation and apparel price deflation, abating.