3 Reasons Men's Wearhouse's Stock Could Fall

Men's Wearhouse (TLRD) is one of the largest retailers of men's suits and the largest tuxedo rental provider in the U.S. and Canada. Its footprint expanded immensely following the June closing of its acquisition of Jos. A. Bank. The deal excited investors so much that its stock price has soared 45% over the last year. Although there are reasons to believe Men's Wearhouse's stock price will continue its upward climb, there are also a number of reasons the stock price could fall in the coming months and years. No one can be certain which will be the case, but investors should carefully consider the following three concerns before investing in Men's Wearhouse.

Merger synergies may not materialize

Men's Wearhouse finally won its battle to acquire Jos. A. Bank, but not before agreeing to pay a princely sum of $1.8 billion. That's 18 times Jos. A. Bank's pre-tax profit and 28 times its after-tax profit. The high price will destroy shareholder value unless the combined company can exploit tens of millions in potential synergies.

Finding and exploiting synergies may be easier said than done. Although both companies sell men's suits, they appeal to different customers. Jos. A. Bank stocks more conservative inventory, while Men's Wearhouse is trendier. In fact, less than 5% of the combined companies' 25 million active customers shop at both stores. As a result, no costs can be saved by closing stores that are in close proximity to one another; savings must come from somewhere else.

Even so, management believes it can eliminate $100 million to $150 million in overlapping costs by 2018. So far, however, management has only shown how up to $100 million can be eliminated, with no clear path to eliminating costs beyond that. Removing $100 million from the cost structure would reduce the de facto acquisition multiple to just 9 times pre-tax earnings -- a much more reasonable price. However, even if management hits its target, the full amount of savings won't be had for a few years. As a result, investors must wait to see if the Jos. A. Bank acquisition was a value-creator or a value-destroyer. If the latter, Men's Wearhouse's stock price could take a plunge.

Aggressive cost-cutting

Given the company's urgent need to justify the price it paid for Jos. A. Bank, there is a risk that overzealous cost-cutting takes hold over more prudent integration of the two companies. In a statement following the merger announcement, ousted Men's Wearhouse founder George Zimmer expressed his concern that cost-cutting would "come at the expense of happy employees and satisfied customers." And that might be the case.

Of the $100 million in redundant costs identified by management, $76 million come from corporate-level layoffs, factory consolidation, and similar initiatives that could tank morale. In addition to layoffs, the cost-cutting initiative risks sparking a civil war between Men's Wearhouse and Jos. A. Bank corporate-level managers in a battle over which employees stay and which go. In the end, achieving cost-savings goals could come at the expense of a well-functioning corporate machine -- hardly a favorable outcome. As a result, there are significant doubts as to the value proposition offered by the Jos. A. Bank acquisition.

Putting growth before profitability

The high multiple paid to acquire Jos. A. Bank is a red flag that management may be trying to grow at all costs, even if the growth destroys shareholder value. With the stock trading at 20 times consensus fiscal 2015 earnings, management may make a desperate attempt to grow its way into expectations.

Unfortunately, growth was already slow in 2013, and there is no guarantee that the U.S. economy will act as a tailwind in the coming years. Men's Wearhouse reported slightly negative revenue growth last year and just 0.8% Men's Wearhouse-brand same-store sales growth. Jos. A. Bank reported a 1.6% revenue decrease and a 5.8% same-store sales decrease in 2013. It is doubtful that a cost-cutting initiative will do anything to boost these dour numbers. If the economy does not improve, same-store sales growth may be sluggish for some time.

Moreover, most of Men's Wearhouse's revenue growth since 2007 came from acquisitions -- not organic growth. If the Jos. A. Bank acquisition turns out to have been overpriced, there is less reason to believe future acquisitions will be made at prudent prices. Thus, growing its way into Wall Street's expectations could have poor long-run consequences for Men's Wearhouse shareholders.

Men's Wearhouse grows through acquisitions and new store additions. Same-store sales growth has been hard to come by. Source: Men's Wearhouse Investor Day Presentation 2014.

Takeaway

Nothing is certain in retail. Men's Wearhouse might realize over $100 million in synergies without breaking stride. However, any dysfunction caused by Jos. A. Bank's integration could hurt shareholder value and tarnish the company's brand. If that were to occur, Men's Wearhouse's stock price could fall.