Gap: Extreme Makeover

After suffering lagging sales over the past year and a half, the world's largest specialty clothing retailer could be headed for recovery. Upgrading the stock to a buy this week, Bank of America analyst Dana Cohen says Gap (symbol GPS) looks "compelling" and outlined several scenarios for improvement in the next two years.

Cohen cautions that a short-term turnaround is unlikely. "Admittedly, one may need to be patient here, and time may be the biggest risk," Cohen says in a report. Given that the stock, at $18, is currently trading at 11 to 12 times analysts' 2006 earnings estimates, she says, "there is little in the way of expectations near-term."

The San Francisco retailer, which operates about 3,000 stores under the brand names Gap, Old Navy, Banana Republic, and Forth & Towne, has seen sales languish in recent quarters. The holiday season didn't boost optimism: Sales in stores open at least one year fell 9% in December. However, the company rolled out plans in January for a sweeping makeover to revamp store displays, increase customer service in fitting rooms and design clothes faster to keep up with shifting consumer tastes.

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Cohen sees three possibilities for improvement. One leads to a turnaround via Gap's current initiatives. Another involves management changes in the company's senior divisions. If neither of those scenarios play out, Cohen says, a dramatic shakeout could occur at the senior management level.

Cohen's 12-month price target on the stock is $23.

--Katy Marquardt