You Should Worry About This Retailer

William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On June 19 the board of directors of apparel retailer Men’s Wearhouse (NYSE: MW) abruptly fired its Executive Chairman and Founder George Zimmer. Management turnover is never a good sign for a company’s prospects. If you’re an investor you need to worry.

What happened?

The short answer is: Who knows?

The firing of the well-known business figure famous for his catch phrase, “You’re going to like the way you look – I guarantee it” remains a mystery in the investment world as of this writing.

The fundamentals of the company have improved fairly steadily in recent years. Revenue and free cash flow increased 18% and 30% respectively over the past five years. Operating margins and profit margins held steady at 8% and 5% respectively since 2011.

Men’s Wearhouse sports zero long-term debt since 2010. Return on equity held steady at 12% since 2011.

Men’s Wearhouse delivered excellent results in its most recent quarter. Revenue and free cash flow increased 5% and 31% respectively. Cash as a percentage of stockholder’s equity increased from 12% to 14%.

In addition, George Zimmer provided face recognition and a catch phrase that consumers can identify with thereby adding to Men’s Wearhouse’s brand identity.

In the chart below, you can see that Men’s Wearhouse gave up a total return more than tripling the market over the past five years.

MW Total Return Price data by YCharts

Speculation

Men’s Wearhouse’s solid fundamental footing and excellent shareholder returns leave room for a great deal of speculation for George Zimmer’s departure.

One popular theory resides in Mr. Zimmer’s disagreements with Men’s Wearhouse’s board of directors, specifically Zimmer’s “hand-picked” CEO Douglas Ewert who became CEO in 2011 after George Zimmer gave up the role.

The financial media repeatedly quotes George Zimmer as saying, “Over the past several months I have expressed my concerns to the board about the direction the company is currently heading…Instead of fostering the kind of dialogue in the boardroom that has, in part, contributed to our success, the board has inappropriately chosen to silence my concerns by terminating me as an executive officer.”

One possible focal point of the disagreement could reside in the poor performance of the Moores and K&G subsidiary. While overall sales increased 5% in its most recent quarter, sales of Moores and K&G decreased 3% and 6% respectively. This could account for the “my concerns to the board about the direction the company is currently heading” portion of Mr. Zimmer’s quote.

Insider sales also loosely support the board turmoil theory. On May 6, an Executive Vice President of Distribution, James R. Bragg II sold 2,068 shares in a direct open market sale. Two days later, Vice Chairman David H. Edwab sold 10,000 shares in a direct open market sale. Any reasons cited for these insider sales represent pure conjecture; however, seeing roughly 12,000 shares being sold off by two executive level employees gives indication of possible troubles down the road.

Retail pressure

The competitive pressures in the retail sector remain immense. Any given retailer deals with multiple competitors. The managers of these companies sometimes take drastic measures to compete effectively. Some speculate that George Zimmer appeals to an older generation on its way out in terms of spending and life and that Men’s Wearhouse needs to adapt its image to the younger generation such as the Gen X and Millennial demographic.

Some retailers such as specialty apparel retailer rue21 (NASDAQ: RUE) which cater to young men and women decided to take the step of going private so that it could avoid the regulatory distraction of its publicly traded status.

In 2012, rue21 increased sales 19% but free cash flow declined 28% due to increased capital expenditures. rue21 possesses plenty of liquidity on its balance sheet with cash and investments equating to an impressive 36% of stockholder’s equity.

rue21 plans to expand extensively in coming years excluding public shareholders from any of the bounty.

Another apparel retailer, Body Central (NASDAQ: BODY) faced a great deal of turmoil resulting from a buildup of out of fashion merchandise during 2012. This resulted in sales and free cash flow declining 2% and 108% respectively. Heads at the senior level rolled.

Recently, the company installed a new CEO and a new merchandising team with one merchandising executive keeping their finger on the fashion pulse in New York. Hopefully Body Central can clear out the bad inventory and bring in some merchandise that people will pay full price for.

Only time will tell as to whether Body Central can turn itself around. Competition may see to it that it won’t.

Watch and be weary

Companies, such as Men’s Wearhouse, distracted by the publicity surrounding management disagreements can’t focus on growing the top and bottom line. In addition, George Zimmer still owns 3.5% of the company which means he might start selling shares and subsequently produce a drag on stock price appreciation.

Also, George Zimmer may convince friends and family that remain in Men’s Wearhouse’s employ--that could cause trouble for the company. For example, James Zimmer, George Zimmer’s brother remains in the executive position of Senior Vice President of Merchandising.

It’s safe to say that this drama is long from over. George Zimmer may come back and settle things with the board or continued chaos may serve as a distraction from strategic focus. If you are a long-term shareholder be wary.

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William Bias 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!

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