CAN BUFFETT STAKE BOOST GAP?
Byline: Jennifer Weitzman
NEW YORK — Warren Buffett’s investment in Gap Inc. may have been based on its recently depressed price, but it’s a vote of confidence in the retailer’s future that hasn’t been lost on Wall Street.
Buffett’s company, Omaha-based Berkshire Hathaway, disclosed in a document filed with the Securities and Exchange Commission that it sank $204 million for 8 million shares of Gap on Feb 14, representing a 0.9 percent share of the San Francisco-based specialty-store giant. That day, Gap shares rose 3 percent, to close at $24.42 on the New York Stock Exchange.
Buffett, chairman and chief executive officer of Berkshire Hathaway and one of the most respected investors in the world, said in a recent wire report that he would start buying shares again “when businesses sell for less in the market than they’re worth.”
Value investors like Buffett tend to look at solid companies whose stocks prices are depressed over companies, like many recent dot-com ventures, with value based more on hype. Buffett declined to discuss the investment with WWD.
Citing long-standing policy, a Gap spokeswoman declined to comment on individual investments or investors.
Richard Jaffe, specialty retail analyst with UBS Warburg, described Buffett’s investment style as one of patience rather than the search for a quick fiscal fix. “Buffett’s involvement underscores Gap’s value, the visibility of the brand and the likelihood of its resurgence,” the analyst said.
Emanuel Weintraub, of the Fort Lee, N.J.-based consulting firm that bears his name, observed: “Buffett buys things he understands. His company owns interesting simple companies like Cincinnati-based Fechheimer Bros. Co., which make uniforms. He is a value investor who is buying the management, the franchise and on expectations that Gap’s management has gotten the message and will revive the company’s product and merchandise presentations.”
Todd Slater with Lazard Freres said that Buffett is “betting on the management and the turnaround, [newly appointed vice chairman John] Lillie’s ability of putting the pieces in place and strengthening the infrastructure for when the merchandise does turn.”
Gap’s ceo Mickey Drexler has been touted by industry analysts and watchdogs as the “merchandise maestro” who is more than capable of turning the company around. That said, they believe he’ll have even more time to hone in on fashion with Lillie, a nine-year board member, focusing on many operational issues.
Slater said he expects Gap’s margins to recover in the first half of 2002, a catalyst for the stock, and an incentive for forward-looking investors like Buffett. Besides, Slater said, Gap is a lifetime franchise. “There is no question about [its] long-term viability,” he said. “Buffett is probably saying to himself, ‘The Gap is the most dominating [retail] company, and Drexler’s strong management style has steered the company from past contractions,”‘ Slater said, adding that he believes the company will emerge stronger and more profitable, as long as it continues to focus on its infrastructure and discipline.
Slater’s firm upgraded Gap to “buy” from “hold” in the middle of March, saying the company is “positioned to begin a lot of good things once consumers are stimulated by lower interest rates and even some tax incentives.”
Still, not all are on the Gap bandwagon. Anne-Marie Lillestrand, with Thomas Weisel Partners, said in research notes that she maintains her “below-consensus [earnings-per-share] estimates of 90 cents in 2001, which is a 10 percent decline from 2000.” She also noted that the company did not provide earnings guidance for the full year, “which is yet another indication to us of the depth of the problems.”
She said, “a closer appraisal of the underlying fundamentals suggests to us that many on [Wall] Street are overestimating Gap’s earnings potential. The stock does not appear to be attractively valued toward the upper end of its historic valuation range.”
She said that Gap was burdened by a shift in consumers’ apparel tastes toward more focused, distinctive competitors, newness and value as well as oversupply and a lack of merchandise innovation.
Jaffe pointed out that Buffett’s investment in Gap does not signal that Buffett or other investors would now put their money into the specialty-store arena. “The Gap has a unique set of circumstances of their own making, and are not related to the economic situation today or the outlook for fall,” Jaffe mused.
Gap’s price-to-earnings ratio is higher than many other specialty retailers in Jaffe’s world of 16 specialty-apparel stores, including American Eagle Outfitters and The Limited. “The Gap isn’t as cheap as these other stocks because the company has a high-quality team with a record of growth, strong brands and the perspective these businesses can be turned around and regain powerful earnings momentum.”
Still, Gap, having changed the face of specialty retailing, remains the dominant brand in the genre, and most industry insiders said they expect it to get back on track sometime in the back half of this year or early next.
“They are still doing plenty of business, just not enough,” Weintraub added.
According to a study released last week by Teen Research Unlimited of Northbrook, Ill., Old Navy and Gap remain the number one and two brands among teens, respectively. Michael Wood, vice president of the research firm, said: “Gap is still viewed as a cool store from which teens take their fashion cues.” He said teens of both genders depend on Gap to tell them what’s in — whether it’s cargo, leather, khaki, fleece or capris.
Wood blamed some of Gap unit’s struggles on its withdrawal from TV advertising last year. “With this group, you need to constantly remind them why they need to shop in a store,” Wood said. “It is critical.”
CIBS World Markets’ Dorothy Lakner, who has a “strong buy” rating on the company, said she has noticed improvements at Gap, particularly at the Gap division, but not as quickly as she would like. “The Gap is looking more mainstream and the advertising is back, which are both key elements,” she said.
Drexler has said in the past that among the chain’s missteps in 2000 was “trying to be all things to all people.” He noted that Gap’s merchandise got too broad and unfocused, Banana Republic was seen as unchanging over a three-year period and merchandise at Old Navy, the hardest hit of the three U.S. divisions, got too dull and prices too high. “Gap is completely dependent on the merchandising, Lakner said, adding that she expects its operations to soar in the second half, if its mix is properly tweaked.
Gap’s comps started to turn negative in the spring of 2000, and subsequently margins started to plunge, made worse by Gap division’s efforts to change its product flow by extending products’ floor life.
Lazard Freres’s Slater said that Gap had generated record-low operating margins in 2000, the second lowest in the company’s 32-year history. Operating margins plunged 32.1 percent, to 10.6 percent in 2000, after peaking at 15.6 percent in the prior year. “Rarely do you see it drop that dramatically,” Slater said, adding he projects Gap’s operating margin to be close to 10 percent, below its all-time low of 10.3 percent in 1989.
Slater said he was also impressed with the firm’s — founded as a single jeans store and has now swelled to 3,676 units, 2,079 of which are Gap stores — drive to trim down store expansion plans. The company announced in March that it would slow down growth from 20 percent to about a 15 percent unit growth in 2002.