Gap Inc.: Betting on Supply Chain Resilience and Brand Momentum Amid Trade Uncertainty

The apparel industry is navigating a perfect storm of trade tensions, inflationary pressures, and shifting consumer preferences. Amid this turbulence, Gap Inc. (GAP) faces a $100 million to $150 million operating income headwind in 2025 due to tariffs on imports from China and other regions. Yet, beneath the near-term pain lies a compelling story of strategic repositioning—supply chain diversification, brand revitalization, and a valuation discount that may offer long-term rewards. For investors willing to look past short-term volatility, Gap presents a rare opportunity to buy a legacy retailer at a P/E multiple below historical averages, provided trade policies stabilize by 2026.

The Tariff Challenge: A Manageable Hit, Not a Crisis

The company's tariff exposure stems primarily from its shift away from China, where sourcing has dropped to less than 3%, and its reliance on Vietnam and Indonesia (27-29% of sourcing). While new tariffs—30% on Chinese imports and 10% on others—threaten margins, Gap's mitigation strategies are already in motion:
- Supply Chain Diversification: By 2026, no single country will account for more than 25% of sourcing, reducing reliance on tariff-heavy regions.
- Near-Shoring: A 2026 goal to source 90% of U.S. sales from American suppliers, including doubling U.S.-grown cotton purchases, cuts logistics costs and avoids trade barriers.
- Cost Control: Operational rigor has kept inventory lean and inventory turnover strong, even as tariffs loom.

The reveals a stock trading at 10.39–12.78x earnings—45% below its 19.04 historical average—a stark contrast to its 2023 P/E peak of 106.42. This discount reflects market skepticism about trade risks, but it also creates a margin of safety.

Brand Performance: Old Navy as the Engine, Athleta as the Wildcard

Gap's brands are a mixed bag, but Old Navy's resilience is a key stabilizer:
- Old Navy: Delivered 3% sales growth in Q1 2025, with online sales surging 6%. Its focus on affordable basics and e-commerce dominance (nearly 40% of sales) positions it to weather economic slowdowns better than luxury-oriented peers.
- Gap Brand: A 5% sales boost in Q1 underscores its niche in casual, timeless apparel, though margins are thinner than Old Navy's.
- Athleta/Banana Republic: Challenges persist. Athleta's sales fell 6% as it overhauls its product line, while Banana Republic's flat performance reflects declining demand for formal wear.

The shows a 16% pre-market plunge after Q1 results, driven by tariff warnings. Yet, Old Navy's strength and a $2.2 billion cash pile suggest the company can absorb near-term costs without resorting to aggressive price hikes or layoffs.

Valuation: A Buying Opportunity at 10x Earnings

At a P/E of 10.39 (as of May 2025), Gap is priced for pessimism. Even after accounting for the $150 million tariff hit, its 2025 operating income guidance of 8-10% growth excludes these costs, implying a post-mitigation recovery. Comparisons to peers are telling:
- Undervalued Relative to Peers: Abercrombie & Fitch (ANF) trades at 6.25x earnings, while Urban Outfitters (URBN) is at 11.93x—placing Gap's valuation in a sweet spot.
- Long-Term Leverage: By 2026, reduced tariff exposure and a reinvigorated Athleta (if successful) could unlock margin expansion, especially if the U.S. dollar stabilizes.

The Bull Case: Trade Policy Stabilization + Brand Turnaround

Investors bullish on Gap are betting on two catalysts:
1. Trade Policy Certainty by 2026: If tariffs ease or U.S.-China trade relations normalize, the $150 million drag could vanish, boosting operating income by 2-3%.
2. Athleta's Turnaround: A successful relaunch of Athleta's activewear line—targeting health-conscious millennials—could lift margins, given its higher price points.

Conclusion: A Value Play with Strategic Legs

For investors with a 12-18-month horizon, Gap is a compelling contrarian bet—a company trading at a discount to its history and peers, with a roadmap to navigate trade headwinds and capitalize on its strongest brands. The question is not whether tariffs are a challenge, but whether the market has overreacted to them. On current valuations, the answer leans toward yes.

Historical data underscores the risks of short-term strategies. A buy-and-hold approach on earnings days over this period returned -10.96%, underperforming the benchmark's 1.78% return. The strategy also faced a maximum drawdown of -13.18% and a negative Sharpe ratio, highlighting its volatility and poor risk-adjusted performance. This reinforces the need for a patient, long-term perspective to mitigate near-term swings and capture the company's strategic turnaround.

Action Item: Consider a gradual position in Gap Inc. at current levels, with a stop-loss below $20 and a 12-month price target of $35–$40, assuming stabilization of trade tensions and a successful Athleta turnaround.