Gap Inc: Is $GPS Overvalued?

Current Price: ~ $28/share
Projected Yield: ~ 1.77%


Gap is a specialty retailer that sells casual apparel for men, women, and children under Gap, Old Navy, Banana Republic, Piperlime, and Athleta brands. The company operates more than 3,000 corporate-owned stores throughout the United States, Canada, Western Europe, and Japan and 200 franchise stores in the Middle East, Southeast Asia, Eastern Europe, and other parts of the world, as well as direct-to-consumer businesses for all of the brands.

Estimated WACC for the firm today is 11.26% using the Capital Asset Pricing Model and the company's recent SEC filings.

Recent free cash flows and noted growth rates:

Year	FCF $Millions
2003	935
2004	1899
2005	1178
2006	951
2007	678
2008	1399
2009	981
2010	1594
2011	1187
2012	815

Average Annual Growth FCF: ~ 11%

CAGR FCF: ~ -1.5%

Consensus Forecast Industry 5-Year Growth: ~ 14% per year

Consensus Forecast Company 5-Year Growth: ~ 10% per year

Internal Growth Rate: ~ 9%

Sustainable Growth Rate: ~ 21%

Scenario 1
Average FCF (2012, 2011, 2010) is $1199 million

• Start at $1199 million FCF
• Assume a 5-year growth rate in FCF of 10% per year, then no growth or 0% growth in FCF per year forever:

Discounted Cash Flow Valuation

Year	FCF $Millions
0	1199
1	1319
2	1451
3	1596
4	1755
5	1931
Terminal Value	18869

The firm's future cash flows, discounted at a WACC of 11.26%, give a present value for the entire firm (Debt + Equity) of $16864 million. If the firm's fair value of debt is estimated at $1630 million, then the fair value of the firm's equity could be $15234 million.  $15234 million / 489 million outstanding shares is approximately $31 per share and a 20% margin of safety is $25/share.

Scenario 2
All else being equal,

• Assume a 5-year growth rate in FCF of 8% per year, then 0% growth in FCF per year forever:

Discounted Cash Flow Valuation

Year	FCF $Millions
0	1199
1	1295
2	1399
3	1510
4	1631
5	1762
Terminal Value	16902

• Present Value of the entire firm (Debt + Equity): $15403 million
• Value of Equity: $13773 million or $28/share
• 20% margin of safety is $22/share

Scenario 3
All else being equal,

• Assume a 5-year growth rate in FCF of 5% per year, then 0% growth in FCF per year forever:

Discounted Cash Flow Valuation

Year	FCF $Millions
0	1199
1	1259
2	1322
3	1388
4	1457
5	1530
Terminal Value	14273

• Present Value of the entire firm (Debt + Equity): $13429 million
• Value of Equity: $11799 million or $24/share
• 20% margin of safety is $19/share

Sources

Morningstar.com

Yahoo! Finance

Gapinc.com

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.