After Earnings Warning, Jos. A. Bank Appears Headed for Bad Times
Alan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
On Jan. 25th of this year, Jos. A. Bank Clothiers (NASDAQ: JOSB) announced an earnings warning. Management changed its forecast for fiscal 2012, which ended on Feb. 3, 2013. It is now estimating that earnings per share will be about 20% lower than the prior year or about EPS of $2.80. Sales will show a modest increase, but will be well below originally anticipated results. Prior to the warning, analysts had been estimating 2012 EPS of $3.80. During the year, the company opened at least 44 new stores and plans to open a similar amount next year. A bright note is that its online business grew by more than 10% this year, generating about $100 million in sales. The balance sheet and cash position remain strong. In that assessment, I exclude all but these comments on inventory. The inventory policy is aggressive and allows considerable management discretion. The company has not liquidated a significant amount of inventory at less than cost historically. I am not anticipating any major surprise.
According to management, last year’s poor performance was principally due to macro factors beyond its control, and poorer consumer reception of its offerings in the last quarter. It however, retains confidence in its business model.
There is no doubt that JOSB has treated shareholders well in terms of capital appreciation. It is equally true that it has grown sales and profits at well above average rates for a decade. And no matter how one views it, it has built a promotional operation that spends lots of money to move cheap product at high markups, while convincing customers that they are paying a huge discount. After enormous discounts and sales expense, JOSB still earns both gross and operating margins that would be the envy of any menswear retailer. I can only call it alchemy not reality.
Where to now?
The question is; Is this a bump in the road and business will return to normal rather quickly or is this the beginning of a major turning point? In order to evaluate which answer is correct, one has to postulate a reason why it was so successful. Whether or not one believes that the company operated outside of fair trade laws, in virtually every state as well as nationally, it grossly overpriced garments with no basis in fact, did not offer them at full price for any length of time, took its prices almost immediately to a 65%-70% discount, and ran continuous sales to liquidate the inventory through well financed promotions. The fact that management repeated this process year after year, without attempting any correction to their product or pricing to improve full price sell through, confirms to me that their business plan was based on the discounted price, which was always the intended selling price. We can all agree that it deceives and confuses customers. Two things are happening; the law is about to affect the company in the short run, and customers are beginning to respond rationally to its promotional tactics. The company has recently begun to change its promotional approach. I don’t believe it can be successful in creating a new image.
My belief is that the Great Recession created an opportunity for JOSB. Men were simply unable to afford the prices they were accustomed to paying and had to trade down. Whether they understood all along they were being duped and chose to ignore it, or in fact were duped, they found JOSB an acceptable economic and social choice at the time. Times are moving on.
The company has been run by the same group of men, for the most part, since its inception. There is no control shareholder to watch the money and no director or member of management, who is a significant shareholder. Read the proxy statement.
JOSB is reputed to have one of the worst trained and worst paid workforces in the industry. I cannot conceive of it offering the service an upscale buyer requires. It doesn’t sell fashion, quality or service. It only promotes and hopes to gain from creating unrealistic product and price comparisons in the customer’s mind. JOSB make clothes in the poorest parts of the world with the cheapest labor and materials. Anecdotally, except for Ben Bernanke, people have a low regard for the quality of its products particularly with regard to wearability. The company is planning to add another 200 stores. I think its store expansion is a liability, not an asset. Most retailers are trying to control operating costs, by either reducing store count or increasing it very cautiously. In addition, more stores generally means more inventory, another cost most retailers are working to reduce.
Over the years, its sales have grown pretty much in line with store openings. There is not much evidence to suggest same store sales growth. Considering the significance of the Web, the company has yet to reach $100 million in sales on its site. I believe the company is in a segment of the industry that is heading in the wrong direction, doesn’t have the infrastructure for change, and has a business model, which is subject to great risk of increased legal enforcement. The stock should be urgently sold.
The Men’s Wearhouse (NYSE: MW) is probably the closest public company in both size and business to JOSB. In its men’s clothing segment, which includes regular and big and tall, but excluding its Canadian subsidiary Moore’s and its tuxedo rental business, and K&G is a bit larger than JOSB. While it does engage in some promotional activities, it is essentially a more traditional clothing discounter selling many brands. It owns what appears to be a very successful tuxedo rental business. The Moore’s Canadian menswear business has not been doing well, showing negative same store sales growth but is a small part of the business. It also owns K&G, a megastore family apparel business that sells on a highly promotional basis. K&G has been a burden with high operating and occupancy costs, and declining sales. It does not seem to fit in with the balance of the company. Jefferies & Co. has been engaged to develop a plan with regard to K&G. Depending on the disposition of K&G, MW’s clothing and tuxedo rental business appear to offer opportunity for growth. It is worth noting that JOSB has started to compete with MW in the men’s big and tall and tuxedo rental businesses. I don’t believe this will have a meaningful impact on either company. This would appear to be a year for MW to rationalize its business model. Depending on how the disposition of K&G affects its balance sheet, the company could have ample capital to grow. I would not buy the stock here, but it is worth following.
Nordstrom (NYSE: JWN) is listed among the competitors JOSB sites in its 10K. JWN is a fashion specialty retailer selling $11 billion a year through its Nordstrom, Nordstrom Rack (its upscale outlet stores) and online. I could not find the connection in terms of product, pricing, service, or customer profile. In menswear Nordstrom does about 20% of its volume in private label. However, its products are priced within reason and are definitely not promoted as are JOSB clothes. The clothes also hang with multiple other brands for comparison of quality and price. Some of its outlets may be in similar locations but that is the only comparison I see. I can’t verify it, but commonsense tells me that JWN doesn't sell to the same consumer profile. JWN is well known for having a highly trained and well paid sales staff. I don’t understand why JOSB considers JWN a competitor. Nordstrom is performing well and at current prices, seems a reasonable long term hold.
J.C. Penney Company (NYSE: JCP) is going through one of the boldest image remakes ever undertaken in the industry. The scale is massive. In my view, it is an attempt to create a new direction in selling at the moderate price point by creating separate stores or environments in one store with either proprietary or licensed names. It is attempting to develop a consistent high quality level, brand loyalty, and understandable and attractive pricing. I see it as an attempt to escape the world of promotional discounting that could in its own arena be as significant as what Wal-Mart and Costco have done. It is entirely possible that if JCP is successful, there will be much less demand for the promoters of the world. Obviously, it is a very controversial project. I believe it can be done. For now, it is on my watch list. I must confess I am caught up in the excitement of what management is trying to accomplish.
Alan Ginsberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!