Fool on Call: A Wrinkle in Men's Wearhouse

I couldn't help noticing that Men's Wearhouse (NYSE: MW  ) gets precious little attention. The clothier has a $2 billion market cap, nearly four times that of scrappy competitor Jos. A Bank (Nasdaq: JOSB  ) , not to mention an equal number of Wall Street analysts covering it, and what looks like a similar level of news coverage. Yet more than twice as many people have rated Jos. A Bank on the Fool's new CAPS service.

Though Jos. A Bank is slightly more profitable than Men's Wearhouse, the latter does put out a nicer return on equity. Men's Wearhouse may seem a bit sleepy, since it's quickly approaching the 600-store level for its core Men's Wearhouse division -- a store count beyond which management believes it could be tough to grow -- but the 42% stock price run-up over the past year versus Jos. A Bank's 11% drop is certainly nothing to get drowsy over. Of course this observation didn't escape CAPS members -- as of yesterday, Jos. A Bank had a three-star rating, while Men's Wearhouse sports a perfect five stars among the Fool's stock-rating community.

Unfortunately, investors thought yesterday that Men's Wearhouse wasn't as sharply dressed as usual.

The quarter
It's readily evident that the nearly 7% drop for Men's Wearhouse in the aftermarket yesterday was not due to the third-quarter numbers. Sales rose 9.5% year over year to $430.1 million, roughly in line with Wall Street estimates, and same-store sales for the U.S. climbed 3.4%, which was just above the midpoint of the 2%-to-4% range to which management had guided. The K&G line of stores had roughly flat comps, a result that management attributed to a knock-'em-dead 2005 that would be hard to match. The 13% comps growth in the Canadian Moores stores also helped cover for the slower growth at K&G.

In terms of profits, the company posted adjusted earnings per share of $0.60, which easily topped analyst estimates of $0.54. This increase in profitability was driven by a sweet 291-basis-point increase in gross profit margins, against a bump of 34 basis points in sales, general, and administrative expenses as a percentage of revenue.

The downfall?
Against the handsome third-quarter numbers, fourth-quarter guidance didn't look quite so nice to investors. In its press release, the company guided toward adjusted EPS of $0.68 to $0.72, well shy of the $0.79 analysts expected. After listening to the guidance section of the conference call a few times over, though, I confirmed that CFO Neill Davis said on the call that adjusted EPS for the fourth quarter would be in the range of $0.76 to $0.80, adjusting for consolidating some operations to Houston and a new distribution in Pennsylvania. This puts the midpoint of the range slightly below where analysts pegged, but it does capture that $0.79.

At the time of this writing, I have to wonder whether there are some additional adjustments accounted for in the press release, or whether it was simply a mistake. In either case, this EPS forecast difference may have had something to do with the sharp sell-off in after-hours trading. Increased full-year adjusted EPS guidance of $2.50 to $2.54 puts management's midpoint expectation above Wall Street's $2.51.

Earnings aside, the conference call did further confirm that the environment for Men's Wearhouse going forward will be a bit more challenging. Fourth-quarter comps are expected to increase by 1% to 2% for U.S. stores, while Canadian comps are expected to grow 2% to 4%. Full-year comps are expected to be in the range of 1% to 3% for the U.S. and 5% to 7% for Canada.

CEO George Zimmer said that aspects "not within direct control" of management, such as the macro environment, employment, and consumer confidence, have caused a noticeable softening in the business. He said that the company saw this softness at the beginning of the quarter, then noticed it take hold a bit more in November. Based on this observation, management put forth its somewhat low growth projections for comps.

In relation to the weak environment, one analyst on the call also mentioned a study cited in The Wall Street Journal, in which the NPD Group said that suit sales this year have fallen 10%. While company officials declined to comment directly on NPD's findings, they did reiterate that they're starting to see softness, and said that NPD may be directionally correct. I would also note that the same Wall Street Journal article mentioned that suits in the sub-$300 category were the fastest-growing group, now making up more than half of all suits purchased. If NPD calculates its suit-sales numbers based on sales dollars, part of this 10% decline could be due to the falling average price of a suit -- a trend that could work in Men's Wearhouse's favor.

Serving the suit
The Men's Wearhouse team wasn't all gloom and doom over the soft selling environment; quite the opposite, in fact. The team is very excited over what is perhaps the real driver for the company going forward -- namely, the things the company is doing beyond selling clothes in its retail stores. Revenue from non-apparel sources now makes up 15% of total sales, and the group grew 24% over last year. These revenue sources include tuxedo rentals, corporate uniforms, and dry-cleaning and laundry services.

Back in 1999, the company started renting tuxedos through its Men's Wearhouse stores, and the project has been very successful. Not only have customers taken to this particular offering, but the company is also seeing a good number of conversions from tux-rental customers to retail-store customers. While the dry-cleaning and laundry services are still relatively nascent, the company has seen good uptake in this area, and it expects similar retail customer conversions based on the successes so far.

On the corporate-uniform front, the company announced that TwinHill, its corporate apparel division, has received three large contracts from Northwest Airlines, USAir, and a third undisclosed customer. These contracts collectively amount to $75 million in revenue over the next five years. These business units have more of a runway than the core business does, and the company has seen better gross margins from all of these units than it has in its core business.

Stable apparel
Because of its product mix, Men's Wearhouse looks very utility-like in the notoriously finicky apparel industry. Though it's obvious after this call that the company isn't immune to economic slowdowns, I think it's more insulated from weaknesses in the macro environment than its counterparts on the high-style side, such as Guess? (NYSE: GES  ) or Nordstrom (NYSE: JWN  ) .

With that in mind, even in the best of times, it will be tough to expect flashy growth numbers from this company. But as it continues to do things like expand its non-apparel business lines and increase the percentage of its sales from its private-label brand, increases in margins could be very rewarding for shareholders.

Again, it's hard to say whether the droop in Men's Wearhouse's stock is due to adjusted EPS numbers in its press release or the low comps expectations, but it sounds to me as though management is continuing to make moves that are broadening and improving the company. I might wait to see how the fourth quarter shapes up, but any further weakness could be a good chance to pick up some cheap shares. A 42% gain over the past year says that somebody sure liked the way Men's Wearhouse looked!

Fool contributor Matt Koppenheffer may not always be a sharp-dressed man, but he never misses an opportunity to say "viva Las Vegas." He does not own shares of any of the companies mentioned. The Fool's disclosure policy is always finely tailored.


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