By Ronda Fears
Nashville, Tenn., Dec. 16 - Gap Inc. has come a long way in its turnaround and there is a real opportunity for even more, said Sri Nadesan, convertible analyst at Wachovia Securities, Inc.
"After almost two years of credit deterioration, Gap has the real opportunity to reduce leverage and improve its credit statistics over the next year."
Gap's 5.75% convertible due 2009 (Ba3/BB+) has risen 35 points in the past two months and the conversion premium has contracted to 30% from 57%.
While there has already been a sharp rise in Gap, the analyst said that the credit is still improving.
"As Gap Inc. appears to be turning the corner in terms of same-store sales performance, the credit spreads on the convertible and straight debt have tightened commensurately," Nadesan said in a report Monday.
Same-store sales performance for the past two months, October and November, was in the positive category after 29 straight negative months, he noted.
"The implied credit spread on the senior convertible is now 437 bps over Treasuries, considerably lower than the 800 bps level that prevailed in October," Nadesan noted.
Gap's straight debt also is trading around the level of the implied credit spread of the convertible.
For the last 12 months at Nov. 2, Gap's leverage ratio (long-term debt/EBITDA) stood at 2.5x, down considerably from 3.2x at the end of the previous quarter, due to EBITDA improvement, the anlayst said.
"Although the current leverage is higher than the 1.7x at the end of the last fiscal year, Gap has the opportunity to take the leverage ratio to 2.1x just by paying down the $500 million of debt that is coming due next year," Nadesan said.
"The company has cash and equivalents of about $2.5 billion, therefore it should not have any difficulty paying down the debt coming due next year."
Furthermore, the analyst added, "The leverage ratio could further improve with gains in EBITDA if same-store sales performance continues to improve."
Gap Inc. 5.75% convertible due 2009
Price: 126.75
Common: $15.70
Conversion premium: 30.1%
Conversion price: $16.12
Current yield: 4.54%
| Yield to maturity: | 1.28%
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| Delta: | 72%
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| 50-day volatility: | 50%
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| Implied spread: | 437 bps
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| Call: | March 20, 2005
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| Call Price: | 102.46
|
| Credit: | BB+/Ba3
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| Note: Prices as of Dec. 13 close.
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