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


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

The Market Intelligence Platform

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.

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

IFRS 9 is a reporting standard for financial instruments that replaces IAS39 (the previous incurred loss standard) with the introduction of provisions for expected credit losses (ECLs) on all financial assets, such as those held to collect contractual cash flows, or held with the possibility of being sold.

The date for adoption was January 1, 2018 and is mandatory for public non-financial corporations (and financial institutions) across a number of jurisdictions outside the United States, including many European countries.

The two key changes introduced by the IFRS 9 accounting standard are:

  • Calculation and provisions must be performed on all affected financial assets, not just the impaired ones, as per the standard it replaces
  • New expected credit loss calculations

Additional challenges will be presented when making assessments for low default asset classes, and companies may find it difficult to access models and sufficient data history.

Impact for non-financial corporations

Non-financial corporations will have some material exposure to many of the financial assets that are defined under IFRS 9. These include investment portfolios, intercompany loans, lease receivables, contract assets, and trade receivables, as illustrated below and further explained in our webinar on IFRS 9 for non-financial corporates.

This, together with the need to assess losses on performing and non-performing assets, might have a material impact on the profit and loss (P&L) of such companies.

ECL calculations under IFRS 9

The IFRS 9 accounting standard introduces new expected credit loss (ECL) calculations that require more data and new models. The key requirements are:

  • Significant increase in credit risk (SICR): Expected loss needs to be assessed at each reporting period to identify a SICR since initial recognition
  • Explicit macro-economic forecasts need to be considered using factors such as the relevant GDP growth, unemployment rate, and stock market index growth figures
  • Credit risk metrics such as probability of default (PD), credit rating, credit score, and loss given default (LGD) need to be adjusted to point in time (PiT), versus through the cycle (TTC)
  • Calculations need to be extended over the lifetime of the assets for underperforming exposures, or in standardized calculations

General versus simplified approach

When performing ECL calculations for trade receivables, the company can choose to take a general or simplified approach (the company is presented with a choice between the two depending on the type of exposure).

  • The general approach uses the 12-month ECL calculation for performing assets (Stage 1 assets) and lifetime calculation for the assets whose creditworthiness has deteriorated since recognition (Stage 2 assets)
  • The simplified approach uses the lifetime ECL calculation for all performing and non-performing assets

The simplified approach can have a bigger impact on P&L expense, as all losses are calculated over the lifetime of the asset, while the general approach can have more impact on P&L volatility, as assets might move between stages incurring 12-month and lifetime calculations.

How S&P Global Market Intelligence can help

A best practice approach used by many financial institutions, which non-financial corporations can also use to comply with the new provision, is to use the existing TTC metrics and convert them into PiT metrics to reflect the current credit cycle, as well as include the required future macroeconomic considerations.

S&P Global Market Intelligence has developed models and tools to help your business undertake the relevant ECL calculations. These models can also be used to assess the creditworthiness of your counterparties and recovery of your exposure in the context of your core business process such as customer credit, supply chain risk, vendor management, and selection and transfer pricing.

The calculation method involves four steps:

  1. We calculate the TTC metric, i.e. the S&P Global Market Intelligence Fundamental PD, CreditModel™ score, for the concerned entity.
  2. We apply our macro-economic model, which weights user defined macro-economic scenarios to produce weighted average forecasted PDs.
  3. We apply a credit cycle adjustment, which converts the TTC risk metric into a PiT PD, leveraging the difference between observed default rates from S&P Global Ratings’ rated universe over last year versus over the past 30+ years.
  4. In addition, as a best practice, we also offer the option to incorporate market-based forward looking information. This is done by further adjusting the PD with the analysis of PD Market Signals country and industry benchmark trends over the past three months versus the past year.

In addition to this quantitative approach available on the Credit Analytics platform, we also offer scorecards that cover low default asset classes for PD, LGD, and point in time adjustments.

Learn More About Credit Analysis
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