Morningstar submits: By Zoe Tan As one of the first national specialty apparel retailers, Gap (GPS) benefited early on from a number of advantages, including size, brand recognition, and long-standing relationships with landlords and vendors. However, given the lack of barriers to entry in the space, and an easily replicable merchandising strategy, this lucrative business attracted competition from all fronts. As Gap's brands fell out of favor, store productivity and merchandise margins plummeted. Therefore, Gap's lease-adjusted returns on invested capital have fallen to the low-teens range in recent years, down from the high teens in the late 1990s. While we believe the retailer's current efforts to reposition brands should yield positive results over the next few years, we are not convinced that Gap can consistently sustain excess returns in the long run, given the lack of product differentiation. Additionally, we anticipate that the competitive landscape will continue to heat up, thanks to the rising popularity of fast-fashion retailers like H&M, Forever 21, and Inditex. As a result, Gap's structural advantages no longer appear sufficient to support a narrow economic moat. In our view, specialty apparel retailers have to possess both a structural advantage and product differentiation in order to consistently generate returns in excess of their cost of capital over the long run. Gap Does Not Possess Product DifferentiationComplete Story »
