Warren Buffett: Slave to Fashion?

The columnist dreams he is the Sage of Omaha and must explain his uncharacteristic investment in a hard-pressed retailer like Gap

Dear Reader,

I am setting aside my usual column to share with you an unreal daydream I fell into the other day. Get this: I was Warren Buffett! And I was preparing my answer to one question sure to come up on Apr. 28, when investors descend on Omaha for Berkshire Hathaway's annual meeting: Just what is Berkshire doing in a fashion-slave stock like Gap? -- RB

Well, now, that's a fair question, especially since our other recent buys include jazzy paint and brick companies. We don't own all that much of Gap (GPS ), and I would hate to break our longstanding policy against talking about trades. But if you check the disclosures that Uncle Sam made us file on Apr. 2, you'll see we picked up 8 million Gap shares last year. My old buddy "Mr. Market" a few days ago said they were worth $200 million. Don't trust that crazy guy, though. It's a fair bet they're worth more--and I'm not saying that just because we started buying Gap stock when it was a whole lot higher (table).

MISTAKES. To see what I mean, anyone can just walk into the nearest Gap. And I mean anyone, almost anywhere. Planet Earth now has some 3,750 Gap, Old Navy, and Banana Republic stores. That number grows daily, and by year's end Gap expects over 4,200 stores--a doubling in four years. Here in Omaha, we've got nine, about as many as we have Dairy Queens. DQ is another Berkshire (BRK.A ) holding that, like our favorite stock, Coca-Cola (KO ), defines ubiquity. And I like ubiquity.

So I urge you to visit a Gap. You'll see good deals on karate pants ($29.50) and an even better one on cargo pants ($24.99, marked down from $42). But look over your fellow shoppers, too. You'll see teenagers, alone and in groups, spending their parents' money freely. You'll see young women, alone or pushing infants in strollers. You'll see aging baby boomers buying outfits that forgive them their paunches. You'll even see grandfatherly guys like me. Look, and you'll see Gap now is the No. 1 cradle-to-grave clothier.

If you're a careful shopper, you'll also see how tough the retail apparel business can be. Just examine the market in boxer shorts. This spring, Gap is trying to sell $12.50 boxers in some nifty prints, with hula dancers, little fishies, or fruit (watermelons, limes, blueberries). On another rack only 10 feet away are last season's boxers. They're identical, except they feature different little fishies or frogs. They're going for $3.99.

Inventory mistakes like this, along with the costs of Gap's global expansion and a looming slowdown in consumer spending, are what have Mr. Market so worried about Gap. He put the shares on the bargain rack, where they're half off last year's price. But this is where Mr. Market is making his usual error: focusing on transitory mistakes and weaknesses, while missing Gap's enduring strengths.

Gap's current financial pressure hides the potential profit power of its unusual apparel franchise. This year looks as tough as last year, when sales expanded 18%, to $13.7 billion, but net profit shrank 22%, to $877 million. That's the bad news. Despite it, Gap's retailing machinery in 2000 generated almost $1.3 billion in cash. With that, plus another $500 million in reserves and borrowings, Gap expanded its retail floor space by 31%--a giant leap, especially after a 28% jump in 1999. This year, Gap sees square footage growing 17% to 20%. After that, 15% growth. As Gap's expansion slows and its new stores become more established, it can look forward to big growth in cash flow.

Gap is bound to make fashion mistakes. Surely some of its new stores will flop. And if tomorrow I conclude I'm wrong about Gap, I would sell and put our capital in a better investment. But you won't hear a word about it from me. As you, my fellow shareholders, know, Berkshire has a longstanding policy against talking about trade.

Questions? Comments? Send an e-mail to barkerportfolio@businessweek.com or fax (321) 728-1711

By Robert Barker

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