Why Gap's Undervalued Stock Offers a Contrarian Opportunity Amid Tariff Challenges

In a retail landscape increasingly buffeted by tariff volatility and shifting consumer preferences, The Gap (GAP) has become a poster child for market pessimism. Yet beneath the noise of near-term risks, the apparel giant's valuation metrics scream contrarian value. With shares trading at a historic discount to peers, strong cash flows, and operational progress in key brands, now could be the time to bet on a long-overdue rebound—if management can navigate the storm.

Valuation Discount: A Contrarian's Dream

The Gap's stock is priced at a 35% discount to the specialty retail sector's average P/E ratio of 15.9x, according to May 2025 data. Its trailing P/E of 10.39 is well below peers like Urban Outfitters (13.9x) and even Abercrombie & Fitch (6.25x), despite The Gap's larger scale and diversified brand portfolio. The EV/EBITDA of 7.00—compared to the sector's 11.66x (as of August 2024)—suggests investors are undervaluing its $1.67 billion in trailing EBITDA.

Even more compelling: The Gap's forward P/S ratio of 0.71 lags far behind the specialty retail sector's average of 0.90, implying the market is pricing in a worst-case scenario for its top-line growth. Analysts, however, are bullish: the average price target of $28.82 (29% above current prices) suggests Wall Street sees a stark disconnect between fear-driven sentiment and fundamental value.

Operational Resilience Amid Tariff Headwinds

Despite escalating tariffs on Chinese imports—a key pain point for global retailers—the Gap has shown surprising resilience. Management's supply chain diversification, including a shift to Vietnam and Bangladesh, has mitigated cost pressures, while its digitally driven inventory management has reduced markdowns.

The Old Navy brand, which accounts for nearly 60% of sales, remains a cash engine, outperforming peers in value apparel. Meanwhile, Banana Republic's recent rebranding efforts—including a focus on modern, gender-neutral workwear—have stabilized same-store sales, hinting at a potential turnaround.

Near-Term Risks: Tariffs and Brand Underperformance

The contrarian case isn't without risks. A 30% tariff hike on Chinese imports, proposed in late 2024, could squeeze margins further unless passed on to consumers—a move that risks pricing sensitive customers out of the market. Additionally, Gap's namesake brand continues to struggle, with declining foot traffic in urban stores.

Analysts warn that the company's operating margin of 5.8%—well below Urban Outfitters' 9.2%—leaves little room for error. A prolonged downturn in consumer spending, particularly in discretionary apparel, could delay recovery.

Why Now is the Time to Buy

The stock's current price—$22.31, 33% below its discounted cash flow-derived “fair value” of $28.77—embeds a margin of safety for investors willing to look past near-term noise. Key catalysts for a rebound include:

1. Tariff Mitigation: The Gap's progress in shifting production to lower-cost regions could reduce its tariff exposure by 20% by 2026, according to internal forecasts.
2. Brand Turnaround: A $200 million investment in Old Navy's e-commerce infrastructure and Banana Republic's omnichannel strategy aims to capture the post-pandemic retail reset.
3. Valuation Upside: At its current price, the stock offers a 12.5% dividend yield on cost if it reaches analysts' price targets—a rare combination of income and growth in a high-rate environment.

Final Verdict: A Contrarian's Trade with 20% Upside Potential

The Gap's valuation is a rare opportunity in a pricey market. While tariffs and brand underperformance pose near-term hurdles, the stock's 22.5% undervaluation and $1.3 billion in net cash provide a safety net. For investors with a 3-5 year horizon, buying now could yield a 30%+ return if the company executes its turnaround and tariffs stabilize.

The risks are real—but so is the reward. This is a stock to buy when fear is high and sell when optimism reigns.

Disclosures: The analysis relies on data as of May 2025. Tariff policies and consumer trends are subject to rapid change.