3 Reasons Men's Wearhouse's Stock Could Rise

Men's Wearhouse (NYSE: MW  ) is the unquestionable leader in the low-priced men's suit market. The stock of the men's apparel company is up an incredible 48% over the last 12 months following a battle with Jos. A. Bank to determine which company would acquire the other. Men's Wearhouse ultimately won out, and now stands to reward shareholders through synergies and growth. Although far from guaranteed, there are three good reasons why Men's Wearhouse's stock price could continue to soar in the months and years ahead. Let's take a look at what they are.

MW Total Return Price Chart

Men's Wearhouse data by YCharts

Merger synergies

Men's Wearhouse acquired Jos. A. Bank in a $1.8 billion acquisition that was completed in June. The total consideration for the deal was a rich 29 times Jos. A. Bank's fiscal 2014 earnings and 1.8 times sales. However, Men's Wearhouse anticipates $100 million-$150 million in annual merger synergies from the deal. If an extra $100 million flows to the combined company's bottom line as a result of the merger, the effective price-to-earnings multiple drops to just 11. If the synergies come through, Men's Wearhouse may have just snatched a bargain.

Even though the two companies stock different styles, there is enough overlap that there are many redundancies that can be eliminated. For instance, consolidating corporate administration (accounting, human resources, etc.) could save almost $50 million. The company believes at least another $50 million can be saved by consolidating distribution centers, centralizing tailoring, and exploiting greater bargaining power in negotiations with advertising media, among other sources of savings.

Of course, it will take some time for these savings to appear. Merging two billion-dollar companies with different corporate cultures takes time and there is execution risk involved. However, the company believes that $75 million in costs will be eliminated within two years and at least $100 million will be gone in 2017. Men's Wearhouse and Jos. A. Bank posted a combined $231 million in operating profit in 2013, so realizing anything close to the expected synergies would give a huge boost to profitability.

Source: Men's Wearhouse 2014 Investor Day Presentation

Firmed up pricing at Jos. A. Bank

Men's Wearhouse and Jos. A. Bank are both known for deep discounts, but the former's promotions are more profitable than the latter's. Whereas Men's Wearhouse typically offers "Buy 1, Get 1 Free" deals and earns low-60s% gross margins, Jos. A. Bank gives more generous "Buy 1, Get 3 Free" deals and earns mid-50s% gross margins. Both companies earn solid margins -- reflective of their high-margin product mix and a proclivity for overpricing inventory so that the promotions seem incredible -- but Jos. A. Bank's could be higher. Management plans to slowly dial back Jos. A. Bank's promotions to bring its margin in line with Men's Wearhouse's.

Another benefit to firming up pricing at Jos. A. Bank is that it could eliminate the ability of customers to take advantage of the lower price. About 1.1 million of the two companies' combined 25 million active customers shop at both Men's Wearhouse and Jos. A. Bank. Moreover, Jos. A. Bank's margin on clearance items was down to about half that of Men's Wearhouse midway through 2014. Leveling pricing between the two stores could make those 1.1 million active customers more profitable to the combined company by eliminating clearance-pricing competition.

Bringing Jos. A. Bank's overall gross margin up to 60% would add at least $22.7 million to gross profit that would flow through to operating income. That would boost Jos. A. Bank's operating income by over 20% and the combined company's operating income by nearly 10%. Achieving this would be a boon to the stock price.

Focus on the stores

Finally, investors should be excited about Men's Wearhouse's opportunity for new store growth in the years ahead. The company has identified 68 potential Men's Wearhouse locations to add to its existing base of 668 locations. It plans to open 30 Men's Wearhouse locations this year and next, and 30 Jos. A. Bank locations this year. Adding 90 new locations would increase total store count by about 7% over the next two years.

Moreover, Men's Warehouse and Jos. A. Bank comparable sales are largely positive. Since 2011, Men's Warehouse has averaged 5% comparable sales growth. Jos. A. Bank averaged 2% comparable sales growth over the same period. Both had a robust 2011 and a rough 2013, but sales growth should be in the mid-single-digits for both companies in a normal economic environment. This growth, combined with new store additions, adds a margin of safety to the investment in case not all of the planned-for synergies are realized.

Takeaway

Men's Wearhouse has a lot going for it. Even after a steep rise in its stock price, investors could still profit by sticking with the combined company. If it can realize the planned synergies, firm up pricing, add new locations, and grow same-store sales, then Men's Wearhouse could be set for another big rise in its stock price.

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