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.

IN PICTURES: 8 Ways To Survive A Market Downturn

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.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  2. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  3. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  4. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  5. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  6. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  7. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  8. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  9. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  10. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center