(Quan prepared this post before Jos A Bank’s offer for Men’s Wearhouse was made public. The Skype transcript that follows Quan’s original post happened on the day the offer was made public.)
I found The Men’s Wearhouse (MW) in the list of companies with lower than 8 EV/EBITDA and with more than 10 consecutive years of positive earnings. MW sells men’s suits and provides tuxedo rental products.
After-tax Return on Capital Is over 16%
MW’s 10-year financial result is good. Over the last 10 years, sales grew 6.7% and EBITDA grew 9.1% annually. In the meantime, MW generated more than $800 million free cash flow. So, 10-year average FCF is $80 million.
Net tangible assets (NTA) at the end of 2012 FY was $801 million. Obviously, NTA increases overtime, so it’s conservative to say unlevered FCF/NTA is higher than 10%. Along with sales growth, MW’s after tax returns on NTA is more than 16% a year. That return is good enough to make it an Avid Hog candidate.
MW Is a “Category Killer”
MW’s main business includes operating retail and rental stores. Rental stores are smaller with an average of 1,372 square feet. Retail stores average 5,721 square feet. That’s about 10 times larger than my apartment in Texas. If I recall correctly, that’s a lot bigger than the suit section I found in Macy’s stores.
I noticed in the 10-K that advertising spending was $92.2 million, $82 million, and $89.9 million in 2012, 2011, and 2010, respectively. That’s about a half of NutriSystem’s marketing spending in 2008, and close to NutriSystem’s $111 million marketing spending in 2012.
Marketing is very important for NutriSystem. They try to convince people to buy $250 meal plans through TV ads. So, I’m surprised to see that a retailer’s marketing expense is close to that of NutriSystem.
Some more information in Wikipedia shows me how MW reaches customers:
“The chain notably ran television and radio commercials featuring Zimmer, and the oft-repeated slogan: “You’re going to like the way you look; I guarantee it.”
I think that people don’t buy suits often. People don’t go to the stores often like people going to Wal-Mart. So, MW advertises to let people know that they can find suits at MW’s stores. People will think about MW when they want to buy suits.
So, I think of MW (and its competitor Jos A Bank) as a “category killer”. They’re similar to Best Buy, Home Depot, PetSmart, etc. They wipe out tiny local competitors by scale. Most local competitors have small store size and no advertising budget. Category killer’s stores are in more visible locations and their ads focus on low price and wide selection.
MW Can Effectively Compete with Department Stores.
Department stores may have a traffic advantage over MW. Men may go to department stores often to buy other things, and notice that they can find suits there.
But department stores have a rent per square foot disadvantage. Department stores that have men’s sections with suits are usually anchor tenants in malls like Nordstrom, Macy’s, etc. Rents in good malls are expensive. Department stores that have really good selection might be more high-end. So, MW can offer a wider selection of suits to the masses.
The traffic advantage of department store may not be very important. A suit is an expensive item. Customer can make a special trip instead of impulse purchase. So, having a good selection might be more important. Jos A Bank and Men's Wearhouse just need to let men know that they can find a wide variety of suits at affordable price in their stores.
There Is No Pricing Power
MW and Jos A Bank may have some competitive advantage in this niche. But unlike Tandy Leather, this is a very competitive market. And suits are expensive so customers pay much attention to price. There’s no pricing power. MW’s gross margin is only about 40% compared to Tandy Leather’s 60%.
I’m surprised at Jos A Bank’s 60% gross margin. I’ll have to look further at the company and discuss it in another post.
Men’s Wearhouse Is More Durable than Most Retailers.
Although we usually avoid retailers, I think that it can be easier to understand MW than most retailers. MW isn’t vulnerable to fashion trend like most apparel retailers. Suits don’t change much. Trends are more predictable in men’s attire. I’m not worry about inventory risk or picking a hot retailer.
I don’t think online competition would be a big threat. The most important factor when buying a suit is how well it fits you. So, men would prefer to try it on in stores. MW faces a much smaller threat from online competition than some big box stores. MW is even less vulnerable to online competition than shoes stores because the sizing is less standardized.
Geoff told me about the fact that people buy fewer suits overtime:
“There is, however, a societal trend you should keep in mind. When my Dad started work at The Bank of New York in Manhattan he probably owned 5 suits. By the time he retired 30 years later, he probably owned one suit (and used it only for client visits). In many industries, American men no longer wear suits to work.
They are still important for special occasions. And people need suits, etc. for weddings, funerals, and a few other events. This is why you see so much about rentals, etc. People actually wear suits a lot less now.”
However, the social trend has largely happened. There may be further declines, but the bigger decline has happened. MW and Jos A Bank grew by gaining market share from smaller, independent stores. There will be fewer companies staying in the business overtime. So, declining market doesn’t mean companies that stay in the business will decline overtime.
MW Is a Good Candidate for The Avid Hog
The price is quite good. Last year’s EBITDA was $284 million. The market cap is now $1,640 million. Net cash is $32 million. So, EV is $1,608, and EV/EBITDA is 5.67. Maintenance CapEx for a retailer is small. Even assuming each dollar of EBITDA turns into 50 cents of after-tax owner earnings, EV/owner earnings is about 11. That’s a good price.
MW’s price is also good if I capitalize rent expense. Rent expense is $169.4 million. Using 8 times rent, capitalized EV would be $2,963 million. Capitalized EV/EBITDAR is about 6.54, which is low in today’s market.
So, from my brief research, MW is a good candidate for The Avid Hog. But until we decide to devote one month to research MW, we’ll have to do a lot of scuttlebutt, and learn more about suits.
(When Jos A Bank’s offer was made public, Quan and I discussed the two companies. Here is the transcript of our discussion on Skype).
Geoff’s Thoughts on Image Positioning
Geoff and I recently discussed about Men’s Wearhouse (MW) and Jos A Bank (JOSB). I learnt about image positioning from the discussion. Image can be important in learning about a retailer’s durability. So, I would like to share our talk to readers of the blog.
Geoff Gannon: Did you see that Men's Wearhouse announced that they rejected a $48 a share offer from Jos A Bank?
Quan Hoang: I didn't hear the news
Geoff Gannon: Yes. You can see an article about it on Bloomberg (and elsewhere) right now. The stock is up 20% or so this morning.
Quan Hoang: I see. It's now $45. It's interesting to see JOSB's price also increased 8%
Geoff Gannon: That's unusual. Usually, the buyer's stock would not go up. Of course, they rejected the offer. But that means the market thinks it would be a good deal for Jos A Bank. Also, the offer was made in (I think) mid-September. Weeks ago. It's just that they went public now. Do you think Men's Wearhouse is right to reject the offer? Do you think it would be a good deal for Jos A Bank?
Quan Hoang: I think so, MW is quite cheap.
Geoff Gannon: Would you be interested in a combined company?
Quan Hoang: Yes, I am. I guess they'll keep two brands separate. But at least the competitive position would improve.
Geoff Gannon: Of course, we don't know if they ever will combine. And we don't know how much would be paid to shareholder of MW to get the deal done. And we don't know what the market price of the combined company would look like. Any other thoughts on Men's Wearhouse and Jos A Bank?
Quan Hoang: I think they're good candidates for The Avid Hog. But now MW is not very cheap, JOSB may be a better candidate. I read something in the internet about the two companies and my impression is that JOSB is a better company. What do you think?
Geoff Gannon: I'm not sure JOSB is the better company. I'm sure they've had more success in recent years.
Quan Hoang: That's from customer's perspective.
Geoff Gannon: Both from the customer's perspective and from Wall Street. Their marketing, etc. worked better. They grew. In retail, customer perspective and Wall Street perspective are often the same. When you are clicking with customers, Wall Street likes you. When you aren't, they don't.
Quan Hoang: Do you think marketing effectiveness is just cyclical like what happen to the big networks?
Geoff Gannon: I don't know. I think Wall Street, retail experts, etc. tend to assume that a company is better because its marketing is more effective. It would be like them saying that CBS has more viewers than NBC because programmers at CBS are smarter than NBC and they always will be. Often, the perception of company quality and management quality is really just the "glow" of the last 3 years results in terms of same store sales.
There is momentum in retail, restaurants, etc. Once you catch a marketing trend that works, you set off word of mouth, improved perception of your brand, etc. One smart decision can trigger a wave that lasts a few years. But it may all go back to just one smart decision. And you may not really be better at making smart decisions than the competition.
Quan Hoang: But these two companies have their stores and the business is not disruptive. So can they always stay in the business and improve the business by some smart decisions?
Geoff Gannon: Maybe. There have been men's clothing stores that failed in the past. Most were never as big as these chains. Because there weren't many national retail chains of any kind - there weren't category killers - back then. But companies like Bond Stores did fail. They were the leading men's clothing store in the 1960s.
Quan Hoang: Are they similar to JOSB and MW?
Geoff Gannon: Nothing was exactly similar back then. But, yes, they were. But it was a more general business back then. So it was more open to direct competition from many sources - because this was more everyday wear for men in cities. I think they suffered when major department stores expanded from a few locations in a city to going national.
Today, the category is more special. And it is more dominated in terms of breadth etc. by these two companies. So I'm not saying it's the same. But there were men's fashion stores - stand alone and as part of department stores - that failed.
Many of the big retailers founded before 1970 are no longer around today. The U.S. retail market is very different today from what it was before about the time WMT etc. started. It was very different in the 1960s and earlier. A lot of things changed that. Computers were part of it, national advertising was part of it, and logistics was a lot of it. But there was a mass extinction of retailers that were strong in the 1950s and 1960s.
What do you think of the durability of the 2 companies? Combined or separate?
Quan Hoang: I don't think there's any difference in durability if they are combined or separate. What do you think?
Geoff Gannon: I agree. The greatest risk to their durability is poor image. A competitor can come along - it can be founded tomorrow - and cultivate a better image that resonates more with modern customers and succeeds. I don't see problems in terms of cost and such. Just the risk of a societal change, image problem, etc.
For example, my Dad went to Jos A Bank. But he would never go to Men's Wearhouse. He would love to go to Brooks Brothers. But they were often too expensive. Once every couple years, he made a special purchase at Brooks Brothers (his favorite). A couple times a year he might go to Jos A Bank (when he saw some sale they were having). And he wouldn't be caught dead in a Men's Wearhouse. Just a matter of image.
Quan Hoang: Customer loyalty seems to be strong. I can feel that. Can it be explained by habit or something deeper?
Geoff Gannon: It's not habit. People rarely go to these stores. It's mindshare. Brooks Brothers is to men's suits what Tiffany is to women's jewelry and what See's is (on the West Coast) to boxed candy. If you are going to buy your wife chocolate for Valentine's Day it will be - if you live in California - See's. If you are going to get her jewelry, it had better come in that blue box (Tiffany). Putting the same piece in that blue box suddenly makes it more valuable to her. And so the company can charge more. This is true both in the U.S. and in Japan. If you are going to buy a suit for your first real professional job in Manhattan or whatever, you are going to "invest" in something from Brooks Brothers.
Now, maybe, if you have to replace something or whatever you are going to consider Jos A Bank and Men's Wearhouse or whatever. But, when you make those big life purchases - with the most emotional importance - they are going to tend to be the See's, the Tiffany, and the Brooks Brothers of the world that you go with.
But it isn't loyalty at all. It's the opposite. You may never have bought a suit. But people you know have. You will rarely buy expensive jewelry. But you know what names you have heard women talk about. It's like that. It is the name and the name alone that creates value. It's like a standard. You may not even know how to compare them. Unlike cars, dishwashers, etc. there are no features to compare. You compare on "quality" as an abstract idea. And so you trust the name everyone trusts.
Think of it this way: What is the risk of making the wrong choice? You are going to spend a lot of money at any of these stores. It might be a relative bargain. But it’s still a huge purchase. It's still either a durable purchase or a really big occasion. So, the concern is not screwing it up. Do you want to pay $600 for a suit that might be good enough or $1,100 for a suit you feel sure will be good enough. It's that kind of thinking.
Quan Hoang: I see, mindshare, that's the word. Is it difficult to replace a customer's mindshare? Or you can only hope to create mindshare with new customers?
Geoff Gannon: The good news is that men's CONSERVATIVE fashion rarely changes. Women's CONSERVATIVE jewelry rarely changes. Boxed chocolate rarely changes. Very fashionable stuff changes a lot. But, what men wear to work, what women want as engagement and anniversary jewelry etc. rarely changes.
It's difficult to create mindshare. Brooks Brothers is one of the oldest retailers of its kind. It's been well known for over a century. Same with Tiffany. In all the time Berkshire owned See's it never succeeded in growing mindshare East of the Mississippi. A huge portion of profits still come from California. Tiffany is super successful in the U.S. and Japan. It's a little mixed elsewhere.
Quan Hoang: but I mean is it difficult to replace the mindshare Jos A Bank has with your dad (after brook brother)?
Geoff Gannon: I think that really comes down to "positioning". My Dad thought in terms of Men's Wearhouse (low end), Jos A Bank (middle range), and Brooks Brothers (high end). And then he saw himself as a middle range sort of guy. It's like watches. He would buy a $200 watch (like a Movado or lesser) not a $2,000 watch. But he also wouldn't buy a $50 watch.
It has to do with perception of quality versus perception of how much - given his income, etc. - is simply too much to spend. Probably some of it came from where other people at his work, etc. got their suits. There's a peer pressure element and there is a self-image element.
Also, Jos A Bank employed a sales approach rather than everyday low prices. So he may have liked the idea he was getting a bargain.
Quan Hoang: how can Men's Wearhouse reverse the image?
Geoff Gannon: JC Penney tried. It's easy to change your image. It's hard to change your image, attract new customers, and still keep your old customers.
Quan Hoang: Do you mean it's easy to create new image with new customers? But is it easy to create new image with someone who has some bias like your dad?
Geoff Gannon: You can change image with everyone. But you will alienate your existing customers. It is like changing the menu at a restaurant. You may bring new people in, but you will drive some existing customers away. JC Penney didn't hurt its image with new customers. It just annoyed and confused its existing customers.
If people come expecting sales every weekend then Jos A Bank better keep doing sales. If Wal-Mart has everyday low prices, they better not start doing higher prices combined with frequent sales. That's what I mean about the difficulty of changing your positioning. You have a "position" people are interested in. It's hard to change that unless you are willing to lose the customers who like you now.
Geoff Gannon: Some companies have successfully changed their position over time. It's easiest if you have a bland position. It's easy to turn something pretty blank into something memorable. It's also possible with small incremental changes. Some restaurants like McDonalds and Domino's changed their image a bit over time. Mostly, they were able to introduce some incremental quality improvements combined with different messaging while keeping enough of what people liked about them.
Quan Hoang: It's like incremental changes or disruptive changes
Geoff Gannon: Yes. But here's the important thing. In terms of "position", you are not just saying what the price of your product is. You're saying who it is for. Abercrombie & Fitch can't change their position. It's very clear. Very specific. But that's not just a price issue. It's not like they can introduce totally different style at the same price. They've actually created an image of who their customer is. Some people are attracted to being that customer. Some are repelled by the image they have created.
If the customer doesn't consider themselves a Men's Wearhouse sort of guy, it's not just a matter of pricing. Jos A Bank and Men's Wearhouse could charge the same but have created different images - in the customer's mind - of the sort of person who shops at each place. People shop where they think other people like them (and other people who are like the person they'd like to be, see themselves as) shop. They don't go where they think people they don't want to be like shop. That's the full impact of what I mean by "position".
Some people go to Target instead of Wal-Mart simply because they don't see themselves as a Wal-Mart person. Not because they think the selection is worse.
Quan Hoang: A&F sells more fashionable stuffs than something like suits, so would they be stuck with the kind of customers their position defines?
Geoff Gannon: Yes. They are still stuck with a specific position. That's why they had to create Hollister. It couldn't be market under the same brand. They needed two separate brands: preppy (A&F) and surf (Hollister). You can't mix preppy and surf/skate/etc. Actually, if you look at teen retailers they all compete on fashion but they each try to position themselves a little more focused on one specific subculture or signature piece of apparel.
I don't know the exact numbers, but American Eagle makes a lot more money on their denim (jeans) than the other teen retailers. That kind of fact tends to stay true even through the fashion cycle. So there is both a fashion issue fluctuating all the time but also some positioning issues that stay true longer term.
Quan Hoang: Yes. But how can American Eagle make more money on their denim than other retailers? how does their positioning help them make more money on their denim?
Geoff Gannon: I assume they succeeded best with the most fashionable jeans. And people who wanted them went to American Eagle. And they became known for it. Nordstrom started as a shoe store and even today people think they are better at shoes than other places. It's a question of focus for the company, perception of the customer, etc. I don't know. Apple is known for its design. Part of that is good design. The other part is people who appreciated good design became loyal to Apple.
I don't have a better answer than the idea that you have a specialty - something you do well - and then that attracts a customer base that really loves that specialty and then you try to please them. Almost all fashion designers end up making most of their money from a few specific items they are best known for. They may attach their license to a lot of things. But they become known for perfume, for leather goods, for ties, for glasses. It's a mindshare thing but it's also a feedback loop. You focus on what you do best.
Quan Hoang: Like I have the impression that Guess has good jeans, just because some of my friends say that, and I do see their jeans are good.
Geoff Gannon: Yes. Guess is a good example. That's what they're known for. They may have tried many other things too. But that's what caught on. And, yes, I associate them with that too.
The good news about MW and JOSB is that they are very slow changing areas of clothing. What matters most to durability is actually how attached you become to some specific trend and whether that changes.
For example, Hanes and Fruit of the Loom are the two biggest underwear companies in the U.S. They have been for many, many decades. During that time, underwear fashion changed completely for both women and men. But it didn't matter. They were able to change - slowly - what items they produced. So, for example, they once produced a lot of hosiery for women and now produce very little. They once produced almost no boxers for men. Now that is their best-selling item in a lot of age groups. Colored T-Shirts people wear without anything over them were very unusual in the mid-20th century. They are now a huge item for both companies. The change was huge over decades. Year to year it was small. And neither Hanes nor Fruit of the Loom was too associated with any one particular item, kind of customer, etc. in anyone's mind. So they were able to keep market share even when fashion changed completely.
Quan Hoang: I think MW and JOSB are in a slow changing area of clothes. That's why I'm interested in them
Geoff Gannon: Are you as confident in their durability as PETM, HD, auto parts retailers, and TLF?
Quan Hoang: If they can compete effectively with department stores, I think it's durable. What do you think?
Geoff Gannon: I think it's durable. But I do worry that image matters. No one thinks books at Barnes & Noble were less good because they were cheaper. But some people think cheaper suits are inferior suits. I am concerned that there is more stigma with a category killer in this area than with home improvement, books, etc.
I think - provided suits stay part of the society - there will always be a place for these kinds of stores. The highest end stores need to have an image of exclusivity. You can't put a Brooks Brothers in every suburb even if they could support those prices. That dilutes the brand. So, I think there is durability here. But, I think we don't normally look at retailers. So we have to be very careful.
Quan Hoang: Men’s Wearhouse and Jos A Bank might be stuck with their images. But there's always need for "cheap" suits (or suits for the masses) right? So should we say the image of Jos A Bank and Men’s Wearhouse is durable?
Geoff Gannon: Yes. I think there will always be a place for a mass, low price approach that spans the country rather than just exclusive shops. We just have to be careful because most people who think and write about retailers as investment don't share our focus on durability. We need to be very careful in not relaxing our standards. It is not as easy to predict the market position of a retailer as of John Wiley or Carnival. Other people do not care about that. We do. So we must always keep in mind that retail is always a less settled industry than many of the mature oligopolies we study.
Quan Hoang: Yes
Geoff Gannon: Anything else about MW and JOSB?
Quan Hoang: Not right now, we will go back to these companies in the future.
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