What Old Navy’s spinoff says about America’s cheap clothing addiction

(CNN) — When Old Navy stepped onto the scene in 1994, it seemed certain to shake up retailing. And it did just that.

In four years, Old Navy hit $1 billion in annual sales by hawking trendy, low-priced clothes for Americans across age groups. Old Navy reached kids and teens in a big way, as well as their parents. Last year, Old Navy’s sales were about $8 billion.

The retailer’s strength shows how Americans have become addicted to super cheap clothing. It’s a chain that is emblematic of the staying power that kind of merchandise has in retail — both in boom times, and in bust.

“Customers want exceptional value,” said Oliver Chen, analyst at Cowen. He said the country is gravitating to retailers where “price is part of their DNA.”

Now, after 25 years, Old Navy has become so successful that it is breaking off from its parent company, Gap, Inc. And while there will probably be some bumps ahead for Old Navy, its future looks bright compared to the Gap’s prolonged slump.

Discount is king

Old Navy’s sales at stores open at least a year grew 3 percent in 2018. And it’s not the only discount retailer that is growing, even amid low unemployment and growing wages. Sales at stores open at least a year at TJX — the parent of TJMaxx, Marshalls, and HomeGoods — grew 6 percent during the holidays compared with last year.

Department stores are feeling pressure from discounters. Macy’s, for example, is opening new discount Backstage stores within its larger locations.

Meanwhile, sales at stores open at least a year at Nordstrom’s full price line fell 1.6 percent during the holidays, while it’s off-price Rack stores grew 4 percent.

“You can great clothes that are not very expensive,” Chen said of the industry.

The discount chains are also getting a lift from the hollowing out of the middle in retail, which has left shoppers with fewer choices to find quality stuff for cheap. Bon-Ton has liquidated. Sears is on life support. And Payless going out of business.

Go in, and get out

The Gap, a premium brand known for its denim jeans, logoed sweatshirts, and turtlenecks, is struggling, too. And those problems have often overshadowed Old Navy’s accomplishments.

“We have found ourselves having to debate internally what’s right for Old Navy versus what’s right for one of the other brands,” chief financial officer Teri List-Stoll admitted to analysts Thursday.

Old Navy and the Gap are moving in opposite directions and chasing different customers, which led Gap to free its discount-focused subsidiary at last.

The split, which Gap expects to finalize in 2020, will allow Old Navy to open up new stores in the United States and abroad to reach more budget shoppers, while also expanding online. The company’s other brands — including the Gap, Banana Republic, Athleta, Hill City — will attempt to firm up their higher-income customer bases.

“A lot of this is real estate and location,” Susan Anderson, senior analyst at B. Riley FBR, said of the split.

Old Navy, as well as TJX, Ross and Burlington, are mostly located in strip malls. The Gap is tied to traditional malls, where traffic is slowing.

At strip malls, “it’s easy to park, you go in, you pick whatever you want, and you get out of there,” Anderson said. “Consumers don’t want to go walk through a whole entire mall anymore.”

Steering Old Navy

While Old Navy has been the crown jewel of the Gap portfolio, the brand had its share of troubles.

It flopped during the late 2000s and went through a period of sales declines during the recession and its aftermath. In 2012, Stefan Larsson took over as president of Old Navy. He revitalized the brand by focusing on families and introducing a fast-fashion model that he helped pioneer after a long tenure at H&M.

“Larsson is credited with infusing more fashion into the brand,” while still keeping prices down, said Tiffany Hogan, senior analyst at Kantar Consulting.

Sonia Syngal, who took over as CEO in 2016, will guide Old Navy into its next phase. She began her tenure at Gap more than a decade prior after stints at tech company Sun Microsystems and Ford. Peck touted her “proven track record of results” to analysts Thursday.

“I stepped back and reflected on what I wanted to do at 35 years old,” Syngal told her alma mater, Kettering University, in 2016 of her decision to enter retail. “I thought a lot about when I was in my teens when I did a lot of designing and making of my own clothing,” she added. “I wanted to get back into that creative environment.”

Syngal declined an interview for this story through a company spokesperson. But she has previously said she wants the brand to appeal to a brand range of customers.

“It’s all about inclusivity, democracy, and the democracy of style,” she told ABC last year. Old Navy launched a “Size YES” campaign in 2018, which brought the brand’s formerly online-only plus-size collection to 75 stores.

Uncertain future

Despite Syngal’s success so far, she will still have her work cut out for her.

Although Old Navy’s sales at stores open at least a year increased compared to 2017, sales were flat during the holidays.

“The fourth quarter was disappointing, particularly in stores,” List-Stoll told analysts. She said Old Navy “missed opportunities,” and she blamed the weather for the lackluster holiday period.

Anderson, the B. Riley FBR analyst, said it “was a little bit eye-opening that this past quarter did slow.” She questioned how much growth Old Navy will get from opening up new stores, since more people are shopping online.

Breaking apart from the Gap also means Old Navy loses the advantages of operating under a huge parent.

For example, Old Navy relies on Gap to help it keep down costs and run operations. It runs joint loyalty programs with Gap, shares customer data, and even has a spot on Gap’s website.

“Old Navy has been carrying the business, but it’s been benefiting from the scale of the parent,” said Simeon Siegel, analyst at Nomura Instinet. “This doesn’t put them in a stronger position.”

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