Suit Up With This Stock

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

I like companies that do one thing extremely well. Often companies try to be too much to too many people, and performance suffers because of it. You need to know your market and work hard to dominate it. You need to be laser-focused on your customer base and their needs. This is exactly what Men's Wearhouse (NYSE: MW) does.

Company Overview

Men's Wearhouse is the largest seller of men's suits in the United States and Canada as well as the largest renter of tuxedos, with over 1,200 retail locations and nearly $2.4 billion in revenue. The company has six main divisions:

  1. Men's Wearhouse - The namesake store recorded sales of $1.5 billion in 2011, making it by far the largest division. Revenue grew by 9% in 2011
  2. K&G Fashion Superstore - A value-orientated store aimed at more price-sensitive customers. Sales totaled $375 million in 2011, a 4% increase.
  3. Moores Clothing - One of Canada's largest specialty retailers. Increased sales by 8% to $268 million in 2011.
  4. MW Cleaners - A Houston-based dry cleaning operation. Accounted for $25 million in sales in 2011, a 5% increase.
  5. Twin Hill - US-based corporate apparel and workwear group. Sales of $25 million in 2011, an 18% increase.
  6. Dimensions/Alexandra - UK-based corporate apparel and workwear group. The largest uniform provider in the UK. Recorded $218 million in sales in 2011

Although the financial crisis caused revenues to slump they have since recovered. As the recovery continues and the unemployment rate decreases I would expect annual suit sales to increase. This should bode well for Men's Wearhouse.

Competition

Men's Wearhouse competes with the big department stores such as Macy's (NYSE: M) and Nordstrom (NYSE: JWN). I prefer Men's Wearhouse partially because the company is far more specialized and partially because both Macy's and Nordstrom carry significant debt loads. Macy's carries about $13.60 per share in net debt while Nordstrom carries about $9.60 per share in net debt. Conversely, Men's Wearhouse has no debt.

A more direct competitor is Jos A. Banks (NASDAQ: JOSB). While Men's Wearhouse carries various brands of merchandise as well as private label items, Jos A. Banks sells only under their own private label. While this allows for a superior gross margin compared to that of Men's Wearhouse (~62% vs ~44%), it also means that Jos A. Banks doesn't carry the popular designers that Men's Wearhouse does. This creates the problem that, if someone doesn't like the Jos A. Banks brand, they can't shop there at all, while if someone doesn't like, say, the Kenneth Cole brand, they can simply buy a different brand from Men's Wearhouse. This is why I believe that the Men's Wearhouse business model is ultimately superior.

The Balance Sheet

The first step in evaluating a company's value is the balance sheet. Men's Wearhouse has a pristine balance sheet with no debt and $138 million in excess cash. A current ratio of 2.8 means that the company should have no problem with short-term liquidity. Although 2/3 of the company's current assets are tied up in inventory, that inventory gets turned about twice per year, thus creating ample liquidity.

With a diluted share count of 51 million the excess cash on a per-share basis is $2.70. With a current market price around $32 per share, cash accounts for 8.4% of the current market capitalization.

Financial data from Morningstar

Profits

Although many people look at net income or free cash flow to determine profitability, I prefer to look at owner earnings. Below is the result of my owner earnings calculation for the past 5 years.

Owner Earnings (Mil $)

<table> <thead> <tr><th>2007</th><th>2008</th><th>2009</th><th>2010</th><th>2011</th></tr> </thead> <tbody> <tr> <td>$155</td> <td>$104</td> <td>$145</td> <td>$138</td> <td>$151</td> </tr> </tbody> </table>

The recession caused a drop in owner earnings but by 2011 they have largely recovered. Owner earnings for the first three quarters of 2012 were $143 million, slightly behind the pace from 2011, although this is due to increased capital expenditures. Given the disappointing guidance issued in December for the fourth quarter a 2012 estimate for owner earnings of about $140 million is reasonable.

On a per share basis owner earnings should be about $2.75 per share in 2012. The weakness in the fourth quarter is due largely to Hurricane Sandy and distraction involving both the presidential election and the 'fiscal cliff'. It is likely that this is an aberration and that the pessimism created due to this weakness is ultimately unfounded.

Valuation

In order to estimate the fair value of a share of Men's Wearhouse I will use a discounted cash flow analysis. I will use a discount rate of both 12% and 15% and use these values to define a fair value range. Since I believe that the fourth quarter result is an outlier I will use the 2011 value of $2.96 per share instead of the 2012 value of $2.75 per share in my analysis. For growth, I'll use a 2-stage model with 6% annual owner earnings growth for the next ten years followed by 3% annual growth in perpetuity. For comparison, the average analyst estimate for 5-year earnings growth is 8.3%.

Using the above parameters and adding the excess cash from the balance sheet I arrive at a fair value range of $33.38 - $44.37. This puts the current market price below the lower end of my fair value range.

The Bottom Line

I believe that Men's Wearhouse stock is priced very attractively, especially after the weak Q4 guidance. I don't expect the suit to go out of fashion anytime soon, and with the K&G Fashion Superstore for the low-end and the Men's Wearhouse store for the mid-range, Men's Wearhouse is positioned to maintain its dominance of the suit market for years to come. Much like its suits, Men's Wearhouse stock is a real bargain.


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