Never Mind Khakis, Gap Thrives on Dividends and Stock Buybacks These Days

Gap’s (GPS) January sales drop announced last week illustrated, to no one’s surprise, that the retailer has a long way to go towards a real revival of its brands. For its shareholders, however, bad news never looked so good.

The Gap Stock Chart by YCharts

That 11% one-day gain in a relatively flat market followed both its monthly sales figure announcement – down 4% in January from the previous year – and a new projection of an equivalent decline for its past financial year. (The company officially posts its full year results March 1.) Sad as they sound, both of these figures were better than analysts had predicted, and that led to about a 20% boost in full-year earnings forecasts.

This is more than Gap shareholders have had to cheer about in a long while. Before recent gains, the share price was down about 10% since 2009. But as a huge player in the sector and one paying a respectable (2.3% yield) dividend, investors are looking for reasons to love Gap again. Lately, the company has offered a few.

Thursday’s announcement included a 6% same stores sales gain in January at its Banana Republic stores. The joy was tempered by declines at Gap and Old Navy, but even those weren’t as bad as feared. The company also said it cleared out more inventory than expected, thanks largely to discounting. (Its Old Navy stores became big bargain centers last Christmas.) And analysts have pointed out that lower cotton costs should greatly help earnings this year.

In October, Gap announced plans to close about 20% of all its stores and open more stores in places like China and Japan. The company also has a new brand manager trying to makes its fashion important again. Until around 2004, Gap stood as the definer of casual American fashion, but it has steadily lost sales to competitors like Abercrombie & Fitch (ANF) and Express (EXPR). The quintessential khaki and button-down look that Gap built and rode for years didn’t hold up well in the new millennium.

The Gap Revenues TTM Chart by YCharts

Investors have suffered through Gap’s past attempts at overhauling its inventory, so expectations for newfound popularity are probably pretty low. But a big pull for Gap shares is management’s determination to use its cash to keep investors happy, even when it arguably should put more of it into fashion strategy overhauls. In addition to a dividend that’s risen even as sales declined, the company spends billions buying its own shares. Without those buybacks, shareholders from 2007 might be looking at negative returns rather than minimal gains.

The Gap Stock Chart by YCharts

Gap still has a huge cash pile, with $1.42 billion on hand at last check. But its free cash flow dipped into the red recently. And there hasn’t been anything happening with its profit margins lately to suggest this will bet better soon.

The Gap Gross Profit Margin Chart by YCharts

YCharts Pro rates the $11 billion market cap company as very strong on fundamentals and moderately undervalued. There’s enough cash to assure investors interested in Gap’s income that there’s little risk of a dividend cut. But anyone looking for more than that from Gap shares might look closely at whether the company’s new style, whatever that will be, catches on. Either that or hope for a comeback in khaki.

Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.