Gap's Bear Case Could Soon Transition To Base Case

Shares of Gap Inc GPS fell 11.51 percent on Tuesday trading, after the company reported disappointing sales for its fiscal fourth quarter, and guidance for its first quarter. Following the earnings call, analysts at Morgan Stanley decided to reiterate an Underweight rating on the stock, trimming their price target from $26.00 to $20.00 – although they noted that there’s a considerable probability that their $15.00 Bear case actually plays out.

The firm’s report pointed out that Gap’s first quarter comp guidance was reduced by 5 percent, falling below the analysts’ most bearish 3 percent projection. In fact, “Brand equity concerns continue to rise across all divisions,” the note continued. The situation is particularly worrying at Old Navy, where April’s comp missed consensus by 1,250 basis points.

A Small Step From Bear To Base

Morgan Stanley’s report explicated why the experts believe the $15.00 Bear case could soon turn into their Base case. It’s all about the Old Navy and Gap divisions: if the former fails to ameliorate its comp trajectory and the latter cannot stabilize, the probability of the stock hitting $15.00 in the next 12 months should be considered likely.

The Bear case assumes a 4 percent comp decline in 2016 and a 3.5 percent tumble in 2017. In addition, it models a gross margin of roughly 35 percent for both 2016 and 2017, slightly below the Base case projections of 35.1 percent and 35.4 percent, respectively. Finally, the experts envision (in this case) a 0.5 percent decrease in SG&A in both 2016 and 2017.

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.