The Gap Isn't the Future. Its Lululemon Challenger Is.

(Bloomberg) -- Gap Inc.'s plans to spin off Old Navy made two things clear: The long decline of its namesake brand is accelerating, and its Athleta chain is its best chance of a future.

The company's signature Gap banner, which turns 50 this year, has posted just one quarterly sales gain in five years. That's in stark contrast to Athleta, a women's workout-wear emporium acquired in 2008 that's been consistently called a “growth engine.” Toss in the struggles of denim—the Gap brand's core offering—in an age of athleisure, and going after Lululemon Athletica Inc.'s yoga-pant empire makes sense.

“Athleta is a great business,” said Art Peck, Gap's chief executive officer since 2015. “In my mind, it has an unlimited growth runway.”

That's good news for Gap, which will need a new growth driver when it spins off its stronger sister brand Old Navy next year. The remaining company, which Peck will continue to run, will house everything else. It doesn't yet have a name, but one can imagine it being dubbed something sporty to dovetail with Athleta's momentum. 

The sportswear chain increased comparable sales nearly 30 percent in the past two years combined. When Gap acquired it a decade ago, it sold only through catalogs and the web. Now it has about 160 locations, about a quarter of the number of Banana Republic stores, but Peck has promised to pour resources into it.

Helping Athleta's case that it's the smartest place to spend money among the remaining brands is the clear struggle of the Gap chain. After years of being in denial about the signature brand's sinking ship, Peck is now slashing its store fleet by the hundreds. There are way too many locations that are “tired and worn out and in all the wrong locations,” he said. Those savings should give him more ammo to boost Athleta. 

Peck foreshadowed his growing ambitions in activewear last fall when the company launched Hill City, a men's line that blends casual and workout gear with an edgy vibe. The brand doesn't have standalone stores, but it's available online and, in a telling sign, within some Athleta locations.

Gap doesn't break out revenue from Athleta. Its sales are recorded in a division, which includes much-smaller brands like Intermix, that generated revenue of about $1.1 billion last year.

That's about a third the size of Lululemon, an athleisure brand with a sometimes cult-like following. And while there are stretchy-pants sales up for grabs as Americans forgo khakis and jeans for comfort, taking a big chunk of market share from Lululemon won't be easy. The retailer has a devoted customer base, a growing men's business and has thwarted threats from industry giants such as Nike Inc. and Under Armour Inc. —gains in same-store sales have been in the double digits for four straight quarters.

“Athleta can become a billion-dollar brand,” but it's not going to have the same surging trajectory that Lululemon had because there's much more competition now, said Jaime Katz, an analyst for Morningstar.

Signs of Athleta's promise could be seen on Friday at a location near Union Square in Manhattan that happened to be right next to a Lululemon. As women perused leggings and sports bras, promotions weren't overly apparent—quite the contrast to Gap, which has a reputation for always being on sale.

“It's more affordable than Lululemon and fits better,” said Rochelle Allen, a 35-year-old psychologist shopping at Athleta. “I like the high-waisted options because they fit my body and the calves aren't too tight.”

For the Gap parent company, soon-to-be-spun-out Old Navy has also been a bright spot, attracting price-sensitive families looking for deals on everything from jeans to fleeces. That's helped it grow same-store sales in four of the past five years. Around Black Friday, the chain offered fuzzy socks for $1 a pair, and the stocking stuffer got enough people in the door for analysts to call the chain an apparent winner during the pivotal holiday shopping weekend.

Sonia Syngal, who has led Old Navy since 2016 and will retain the role at the standalone company, said in a recent interview on Bloomberg Television that the brand has been using customer data to enhance the shopping experience. It recently rolled out in-store pick-up and mobile checkout in stores, plus activities for kids like hopscotch and table coloring that make the idea of shopping with families less painful.

“Old Navy is a value-oriented winning retailer,” and should have a higher valuation similar to TJX Cos., said Randal Konik, an analyst for Jefferies. The brand is “well positioned.”

The same can't be said for the Gap brand. Peck is ramping up the kind of cost cutting that has sealed the fate of many other retail chains. And there's the overarching problem of finding a consistent core customer—one that will shop at Gap without needing massive discounts to do so, said Morningstar's Katz.

At a Manhattan Gap near Grand Central Station on Friday, where windows were plastered with discount signs, a group of French tourists picked through racks, but said they weren't going to buy anything. Shopper Courtney Mahon didn't come in intending to make a purchase but was lured by the promotions.

“I saw the 30 percent off, so that made me walk in,” the 26-year-old financial analyst said. “I was really just browsing to kill time, but probably will buy something fitness.”

To contact the editor responsible for this story: Anne Riley Moffat at ariley17@bloomberg.net, Lisa Wolfson

©2019 Bloomberg L.P.