Close your eyes and imagine the stores in the local mall.
Can you pick one of the hottest retail stocks over the last month from the names in that mall? I will give you a few clues. It's not Starbucks (SBUX) , which continues to win amid an ungodly amount of new product introductions in recent months and enhanced mobile ordering features. Guess again if you picked teen apparel retailer American Eagle Outfitters (AEO) -- a perennial favorite of mine -- which will enter the back-to-school shopping period with considerable wind at its sails. It's not even J.C. Penney (JCP) , which has seen its stock surge this year due to the improved financial standing of its customers and optimism around several key new initiatives (appliance rollout, store modernizations).
Give up? It's none other than the absolutely floundering apparel retailer Gap (GPS) -- shares have zoomed about 14% in the last month vs. a 4% gain for the S&P 500. Investors have seemed to latch onto the opinion that Gap's better-than-expected June sales performance is the start of a long-awaited turnaround (I suspect some of the recent upbeat reads on the U.S. consumer have sent the folks who shorted retail exiting the first quarter covering). Same-store sales for June rose 2% compared to Wall Street estimates for a 3.6% drop. News flash to the Gap bulls -- the comp was bought amid intense promotional activity at Gap, Old Navy and Banana Republic. While it's certainly wonderful to see the horribly run Gap beat a Wall Street sales forecast for at least once during the post-Great Recession macro recovery, enthusiasm really needs to be reined in ... a lot.
Here are a couple of reasons you may want to consider betting against the market's apparent excitement over Gap.
Major reorganization likely coming in 2017: When the company said several months ago it would exit certain overseas markets, it signaled something very important (at least to me) -- the entire international store base needs to be reassessed. The reason is because Gap's international results continue to be dreadful due to poorly positioned stores and a lack of respect by merchants to local market conditions. Considering everything that is going on in Europe -- which has stunted demand for Starbucks coffee and cruise vacations from Norwegian Cruise Line (NCLH) -- having exposure to a retailer such as Gap with a fundamentally flawed international business is not too attractive. And it becomes even more unattractive of a proposition in light of a wacky 14% stock gain inside of a month.
Face the truth: There will never be a turnaround at Gap or Banana Republic of any substance. Yes, you heard that correctly -- never. I have covered Gap literally straight out of college in 2004, and I can tell you Wall Street has been perpetually looking for some magical return to 1980s glory for both store concepts. It just never seems to happen, and that was when fast-fashion houses such as Zara and Forever were much smaller and far less powerful. And when sales do gain a bit of momentum at Gap and Banana, it hasn't been anything eye-popping.
The company remains absurdly slow in getting products to market, a revolving door in key positions have led to soulless collections each season that have permanently turned consumers off and the U.S. store base is still way too large. I suspect a weak 2016 holiday season will refresh the minds of the bulls on Gap's uncertain long-term future.
Can't trust management: I think the entire Gap exec suite needs to be house-cleaned. The only way that's going to happen, I fear, is if an activist investor takes a position in the company. Not only have key execs overhyped performance potential during the past two years, there is a general sense they don't know how to run the company. Those in the C-suite who have a rough idea on how to run a retailer lack the sense of urgency needed to turn around a well-known brand such as Gap. The only guy who could perhaps turn Gap into a worthwhile investment is Arthur Martinez -- he turned Sears (SHLD) around eons ago and has quickly driven positive change since assuming the interim CEO role at Abercrombie & Fitch (ANF) .
A few of Gap's execs may not live to make decisions on back-to-school 2017, and it's hard to buy a soaring stock with such an uncertain outlook in the exec suite and a current team that has a poor track record of accountability.