Men's apparel retailer Men's Wearhouse (NYSE:MW) may guarantee that its customers will like how they look, but that doesn't guarantee that shareholders will be happy. Although the company's third-quarter report held no particularly bad surprises, management guided toward a larger loss in the fourth quarter and traders swiftly cut down the price of the stock.
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A Mixed Bag for the Third Quarter
On the top and bottom lines, there was not much to fault about the third quarter at Men's Wearhouse. Revenue jumped 19% and handily exceeded even the highest published estimate. Sales were helped by 13% growth in tuxedo rentals, 8% growth in the retail segment and over $50 million of acquired growth in the corporate apparel segment. That puts overall organic growth more in the range of 8% (and consistent with comp-store growth of 9.6% at Men's Wearhouse) - a level that compares favorably to MW's most direct comparable, JoS. A. Bank (Nasdaq:JOSB), which reported overall growth of 7% and comp-store growth of 3% for its third quarter.
Profitability, however, was more problematic. Gross margins dropped a full point, due in large part to aggressive promotions. Consequently, a more than two-and-a-half point drop in clothing margins offset ongoing improvement in the very high-margin tuxedo rental business. Although operating expense growth of 16% was less than sales growth (so there was positive leverage), that is still a pretty rapid pace of growth - even stripping out some "one-time costs" leaves SG&A growth at 12%; a level that may still concern investors waiting to see whether this company can recapture past margin leverage.
Will Business Model Changes Produce Long-Term Benefits?
Men's Wearhouse feels like a company that is in transition. The tuxedo business is becoming a larger and larger part of the revenue base, and that is not a bad thing (growing any business with 84%+ gross margins is usually a good idea). Unfortunately, K&G looks like a basket case and will need some real attention from management to turn around.
Likewise, it is fair to wonder whether a change in business model may confuse customers. It would seem that Men's Wearhouse has moved more towards a high-low pricing model (with a lot of "buy one, get one free" offers) as opposed to an everyday low price competitor. That is all well and good during those sales, but does it run the risk of leading customers back to the mall and retailers like Macy's (NYSE:M), Dillards (NYSE:DDS) or JCPenney (NYSE:JCP) in the time between sales?
At the same time, the company is expanding its corporate apparel and uniform business, largely through acquisitions. This is not an altogether unreasonable move, and the company probably will not bump up against UniFirst (NYSE:UNF) or Cintas (Nasdaq:CTAS) as some might fear. Nevertheless, it is entirely fair for investors to wonder whether management should be taking on new challenges when the existing business (particularly K&G) has such ample room for improvement.
The Bottom Line
Shares of Men's Wearhouse do not look particularly expensive, but why should they? This company has a relatively poor record of earning a return on invested capital sufficient to generate economic profits, and the trend since 2007 has been rather ugly. Even allowing that the recession hit this company hard and that a recovery is in the making, the company needs to shore up its businesses, firm up its branding strategy and prove that these recent acquisitions will reverse the company's history of making poor deals (or rather, making deals and then handling the acquired assets poorly).
If the company can push all of the right buttons, the stock could work. But with so many other companies to choose from, many of which do not have these problems, is it worth the trouble? (To learn more, see Analyzing Retail Stocks.)
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