DGI Adventure – 09-28-2015 Limit Order Placed – GAP Inc. (GPS) – $29.49/share

Dividend Cycle

GPS goes ex-dividend on 10/5/15. Owning shares before this
date qualifies the shareholder for a $0.23/share quarterly dividend which will
be paid on 10/28/15. The quarterly dividend has been at this level since April
2015 which represented the most recent raise of $0.01/share (4.5% increase).
Another increase isn’t expected until at least spring of next year, but that
seems a strong likelihood as GPS is a Dividend Contender having raised its
annual dividend 11 consecutive years.

Investment

I would like to be a shareholder of record for that next
ex-dividend date, which is why I plan to place a limit order for 51 shares @
$29.49/share for a total investment of $1,510.94 (including $6.95 trade
commission). That limit order represents a ~2% discount to today’s closing
price of $30.13. Why do I want to be a shareholder of record?

The QC (Quantitative
Case)

Payout Ratio

34.07%

10 Year Revenue CAGR

0.13%

10 year EPS CAGR

13.15%

5 year ave P/E – Current P/E (ttm)

+2.3

5 year ave Yield – Current Yield

-1.15%

11 year mean DGR (dividend growth rate)

25.7%

Debt/Market Cap

$1.35B / $12.26B

Total cash

$1.04B

Return on Assets

15.16%

Return on Equity

40.16% (!)

Profit margin

6.95%

EBITDA / Revenue

$2.40B / $16.2B (14.8%)

Reverse DDM Fair Value DGR at buy price

6.88% ($29.49/share)

Assumed DGR (DDM valuation 10% disc.)

7.5% ($36.80/share)

DGR margin of safety

0.62%

 

LOL (Limit Order
Logic) – $29.49

On December 24 2012, GPS closed at $30.43/share. After that
trough, the share price shot on up to its all-time high over $46/share in 2013,
and hasn’t really been close to that until now. There is a peak earlier in 2012
at $28.53/share. This limit order is right in between those two turning points
in the price (both points represents big volume spikes in that year). It also
conveniently represents a pretty tight limit, since if I want in on the next
dividend I need to act before Friday 10/2.

QWaF (Qualitative
Warm and Fuzzy)

Fall into the GAP! Primarily this is a bet on the US
consumer. 78% of GAP’s sales are domestic. Unemployment is low, real wages are
increasing (maybe not as much as the Democrats think they should be, but they
are increasing), fuel is cheap. So what do US consumers do with extra money in
their pockets? I’m the last person to try to pretend that they understand the
average US consumer, but if my wife is any kind of an indicator, they buy
clothes. Now my wife doesn’t shop at the GAP because she’s classier than that.
But a lot of people do shop at the GAP or Old Navy or Banana Republic (all GAP
Inc. Brands). Their newest brand, Athleta, should be well positioned to cash in
on the current “active wear” trend. In other words: basic bitches buying yoga
pants represents a strong growth opportunity.

While the primary thesis is strong consumer spending in the
US, a secondary thesis centers on the fact that GAP is currently focusing its
growth prospects on Asian markets. But I thought the Chinese economy is falling
off a cliff? Emerging markets bad! Arrrrgh! This isn’t warm and fuzzy!

Ah but it is. Yes, China isn’t growing like a teenage boy
anymore, and that’s bad for commodities producers like mining companies and
related industries, because the insatiable appetite for iron, coal, copper,
cement, etc. is probably abating as the economy matures. But what happens to
maturing economies? They transition from raw material consumption to
service-based and consumer discretionary consumption. That is good news for
companies like GAP that have strong brand recognition in the western fashion
circles, which is what the emerging economies’ basic bitches will be emulating.

Finally the tertiary thesis is insider ownership. At the
time of writing there are ~406M shares outstanding. 40.80% of them are owned by
insiders! That is a lot. That means that the current annual $0.92/share
dividend represents a little over $152M of cash for the company insiders. It’s
safe to say that management is motivated to maintain and grow the dividend. I can
only currently expect to get $46.92 per year with my investment in 51 shares,
but I have a pretty good feeling that amount is going to go up as long as the
company can afford it.

CPR (Cold and Prickly
Risks)

Do you know how many freaking apparel stores there are? Good
Lord, there are a lot of apparel stores. This is a highly competitive industry.

Do you know how long it takes for something to go from cool
to not cool? 140 characters or less tweeted by the right (or wrong) celebrity
could be all it takes. Mr. Fashion is just as, if not more, moody and fickle
than Mr. Market, and believe me…they don’t understand one another at all. I
have no idea how companies like GAP Inc. do it, but they’ve been doing it for a
long time.

Top line growth has been anemic to say the least. That’s
probably because of price competition and the fact that GAP just isn’t quite as
cool as it was 20 years ago. The only reason EPS has grown so
disproportionately to revenue is that management has been aggressively buying
back shares. Fortunately management has kept a lot of those shares for themselves,
so they have a vested interest in the dividend. Meanwhile they have a diverse
line of brands and they’re focusing their growth in the right places for my
taste.

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