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Analysts: Old Navy's split from Gap Inc. will help stock valuation

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IFRS 9 Impairment How It Impacts Your Corporation And How We Can Help


Analysts: Old Navy's split from Gap Inc. will help stock valuation

The Gap Inc.'s decision to split into two independent publicly traded companies will finally allow investors to access off-price retailer Old Navy outside the shadow of underperforming brands within the parent company, according to analysts.

"This is really a financial decision about how they [can] create more shareholder value," said Jay Sole, a UBS analyst, in an interview. "The clear beneficiary is the stock price."

Old Navy will become an independent company while the Gap brand, Banana Republic, Athleta, Intermix, and Hill City will form an unnamed company that Gap is currently referring to as NewCo, according to a Feb. 28 press release announcing the split.

Gap's shares closed the day up 16.18% at $29.51 on March 1.

Once the separation is completed, Gap shareholders will own shares in both Old Navy and NewCo in equal proportion, the company said.

In the last few years, Old Navy has shouldered the company's net sales growth, posting continuous net sales increases and hitting $7.84 billion in 2018, in contrast to the declining net sales reported by the Gap Global and Banana Republic brands, an analysis by S&P Global Market Intelligence showed.

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The parent company, Gap Inc., has seen sales rise since 2017 after hitting a low in 2016. The company, which includes all three banners, posted net sales of $16.58 billion in 2018.

Old Navy has also reported better comparable sales growth than the Gap Global and Banana Republic brands in the last few years, although the pace of sales growth at the off-price retailer slowed to 3% in 2018 year over year, compared to 6% in 2017. By contrast, Gap Global posted a comparable sales decline of 5% in 2018 on a year-over-year basis, while Banana Republic Global posted a 1% increase year over year, after posting a 2% decline in 2017.

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Jaime Katz, a senior equity analyst at Morningstar said the announcement did not come as a surprise given Old Navy's performance in the last few years compared to the other brands under the Gap umbrella, adding that giving the struggling brands a focused management team might help turn the business around.

"I think what the management team is attempting to do is refocus separate leadership teams to capitalize on independent demand at each new carved out company," Katz said in an interview.

Gap.Inc's current CEO and President Art Peck will hold the same position with the new company, while Sonia Syngal, currently the president and CEO of Old Navy, will lead the brand as a stand-alone company.

Although Wall Street reacted positively to the announcement, analysts said the split could be challenging given how intertwined the brands are. Losing the ability to leverage synergies such as buying fabric in bulk, shared supply chains, and office locations could lead to additional expenses for both companies.

"That could present a challenge which I’m sure they’ve already thought about this but [brands are] not going to get those synergies that [they] had before," said Susan Anderson, a senior equity research analyst at B. Riley FBR, in an interview.

Anderson added the companies would have to improve their sales performance in order to offset the potential increase in expense.

It's unclear what both companies will incur in terms of expenses from the separation and Sole said that uncertainty could be risky.

"That’s sort of the risk- is that we don’t know what the expenses are going to be. If there is a scenario where sales continue to struggle and expenses are going to be higher than expected, that presumably would put pressure on the stock price of the company," Sole said.

To improve sales, Sole said the Gap brand needs to focus on identifying its primary customer and figuring out how to efficiently meet their demands.

"Gap has sort of tried to be a little bit of everything to all people and in these days, brands can be more successful if they’re more focused," he said.

Analysts are eager to learn more information about the execution of the separation, which the company might reveal incrementally in upcoming quarters or in SEC filings related to the separation.

"We have about probably another year before much of the transparency surrounding this transaction will be offered," Katz said.

The separation is expected to be completed by 2020, the company said.