Navigating Tariff Turbulence: Can Gap Inc. Sustain Its Growth Momentum?

The apparel industry faces a precarious balancing act: managing margin pressures from global trade policies while maintaining brand relevance in a rapidly evolving retail landscape. For Gap Inc. (GPS), the first quarter of 2025 provides a window into how the company is navigating these challenges. Amid rising tariffs and a shifting consumer landscape, its ability to sustain its financial guidance hinges on executing a dual strategy of cost mitigation and brand revitalization. Let's dissect the numbers, risks, and opportunities.

Q1 Resilience: A Mixed Picture of Strength and Struggle

Gap Inc. reported Q1 2025 net sales of $3.5 billion, up 2% year-over-year, with comparable sales growth of 2%. This marks its ninth consecutive quarter of market share gains, driven by the stellar performance of its two largest brands: Old Navy and Gap. Old Navy delivered 3% comparable sales growth, its ninth straight quarter of gains, while Gap's 5% comparable sales jump—the sixth consecutive positive quarter—reflects progress in its brand reinvigoration efforts.

However, the company's weaker brands—Banana Republic and especially Athleta—dragged on results. Athleta's comparable sales fell 8%, underscoring the need for aggressive course correction. Meanwhile, gross margin improved to 41.8% (up 60 bps), aided by operational efficiencies, and operating income surged to $260 million, a 140-basis-point margin expansion. The company's cash reserves swelled to $2.2 billion, a 28% year-over-year increase, providing a critical buffer for future challenges.

Tariff Pressures: The Elephant in the Room

The elephant in the room is tariffs. Gap Inc. now faces an estimated $250–$300 million in incremental costs in 2025 due to tariffs on Chinese imports (30%) and other regions (10%). Management projects these tariffs could reduce operating income by $100–$150 million, with over half of the impact mitigated through pricing adjustments, supply chain optimization, and operational efficiencies.

The company's mitigation playbook includes:
- Price hikes: Modest price increases on select products to offset tariff costs.
- Supply chain shifts: Diversifying sourcing to reduce reliance on high-tariff regions.
- Cost discipline: Maintaining tight control over rent, occupancy, and inventory management, which contributed to margin improvements in Q1.

Risks and Red Flags

While Gap's strategy shows promise, three critical risks could derail its outlook:
1. Tariff Volatility: Further escalation in trade tensions or retaliatory measures could increase costs beyond projections.
2. Brand Performance: Athleta's struggles and Banana Republic's stagnation threaten to dilute the gains from Old Navy and Gap.
3. Inventory and Liquidity: A 7% year-over-year inventory rise (to $2.1 billion) and negative free cash flow ($223 million) signal potential execution risks, especially if sales growth falters.

Is the Financial Guidance Achievable?

Gap Inc. projects 1–2% net sales growth and 8–10% operating income growth for 2025, excluding tariffs. Given its strong cash position and the mitigated tariff impact, these targets appear within reach—if management executes flawlessly.

• Positive Leverage: The 140-basis-point margin improvement in Q1 suggests operating leverage is intact. If Old Navy and Gap continue to drive market share gains, top-line growth could accelerate.
• Liquidity Cushion: $2.2 billion in cash provides flexibility to navigate tariffs and fund brand reinvestment without diluting shareholders.
• Execution Risk: The real test will be whether Athleta's turnaround and supply chain adjustments offset tariff headwinds in the second half of the year.

The Investment Case: Cautious Optimism, but Watch the Tariffs

The stock's 15.76% aftermarket surge on Q1 results signaled investor optimism, but this enthusiasm faded as tariff risks came into focus—a reminder of the volatility ahead.

Historically, such momentum strategies around earnings have been problematic for GPS investors. A backtest reveals that buying GPS on earnings announcement dates and holding for 20 days from 2020 to 2025 resulted in a cumulative loss of 31.1%, with a peak drawdown of 32.16%. These results highlight the risks of post-earnings volatility, underscoring the need for disciplined risk management.

Bull Case: If Old Navy and Gap sustain momentum, tariffs remain stable, and Athleta turns around, Gap could exceed its 2025 EPS target of $2.07. Its valuation—trading at 13x forward earnings—remains reasonable versus peers.

Bear Case: A further tariff escalation or prolonged weakness in Athleta could force the company to revise guidance downward, pressuring the stock.

Final Take: A Strategic Buy with Clear Catalysts

Gap Inc. is not without risks, but its Q1 performance and mitigation plans create a compelling case for investors willing to take a calculated risk. The company's strong cash position, operational discipline, and brand strengths in Old Navy and Gap provide a solid foundation. However, success hinges on executing its supply chain and pricing strategies flawlessly while reviving its weaker brands.

For now, the stock offers a compelling entry point—especially as it trades below analysts' $24.50–$34.00 price targets. Monitor tariff developments closely, but consider this a “buy” with a long-term horizon.

Note: This analysis assumes no further tariff increases beyond current projections and successful execution of Gap's strategic initiatives.