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.

Gap Inc: fairly valued at $23/share

I believe Gap Inc. ($GPS), at approximately $23/share is fairly valued on a cash flow valuation basis.  Assuming all else at $GPS meets my standard for good business, I'd buy it today for the long term at $18.

Gap is a specialty retailer that sells casual apparel for men, women, and children under the 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 as well as 151 franchise stores in the Middle East, Southeast Asia, Eastern Europe, and other parts of the world.

I estimated the firm's WACC at 14.11% using the Capital Asset Pricing Model and the company's recent SEC filings.

Recent free cash flows and noted growth rates:

Year	FCF $Millions
2001	-567
2002	378
2003	935
2004	1899
2005	1178
2006	951
2007	678
2008	1399
2009	981
2010	1594
TTM	1186

Average Annual Growth ex-2001: approx. 38%
CAGR ex-2001: approx. 20%
Consensus Forecast Industry 5-Year Growth: approx. 16% per year
Consensus Forecast Company 5-Year Growth: approx. 11% per year

Assuming the company achieves a 5-year growth rate in FCF of 11% per year, and assuming that after the next five years, the company achieves no growth in FCF or 0% growth per year forever:

Discounted Cash Flow Valuation

Year	FCF $ Millions
0	1186
1	1316
2	1461
3	1622
4	1800
5	1998
Terminal Value	15722

The firm's future cash flows, discounted at a WACC of 14.11%, give a present value for the entire firm (Debt + Equity) of $13,588 million. If the firm's fair value of debt is estimated at $0 million (no debt), then the fair value of the firm's equity could be $13,588 million.  $13,588 million / 614 million outstanding shares is approximately $22 per share and a 20% margin of safety is $18. Assuming all else at $GPS meets my standard for good business, I'd buy it today for the long term at $18.

Sources
Morningstar.com

GapInc.com

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