Men's Wearhouse (NYSE:TLRD) had a tough 2013 as the difficult sales environment for its core tailored clothing business continued and it felt pressured by a restless shareholder base. The company also spent much of the year locked in a tit-for-tat takeover battle with smaller competitor Jos. A Bank Clothiers (UNKNOWN:JOSB.DL). While Men's Wearhouse had initially been lukewarm to a combination with Jos. A Bank, it warmed up to it noticeably in the New Year and recently agreed to buy the company for roughly $1.8 billion. So, should investors bank on good returns from a bigger Men's Wearhouse?
What's the value?
Men's Wearhouse used former CEO George Zimmer's likable image to build a leading footprint in the men's tailored clothing space, and it has built up a current base of more than 1,100 stores around the country. While the company has made efforts to diversify its business that include major forays into the tuxedo rental and corporate apparel areas, it still generates the vast majority of its sales from the tailored clothing category. Unfortunately, that business segment has been in a multi-year decline as consumers have anecdotally shifted toward more casual attire, especially in the workplace setting, which has led to marginal overall top-line growth for Men's Wearhouse over the past five years.
Fiscal 2013 had more of the same for Men's Wearhouse, as the company reported a slight top-line decline mainly because of weak comparable-store sales growth. More notably, the company generated sales at a lower overall merchandise margin because of higher inventory markdowns and margin contraction in its tuxedo rental unit. As a net result, Men's Wearhouse saw weaker operating cash flow so it had fewer funds to reinvest in its growth initiatives, like a further expansion of its corporate apparel business.
Is bigger better?
Of course, the acquisition of Jos. A Bank will undoubtedly make Men's Wearhouse more profitable than either stand-alone company, and management estimates that cost savings of $100 to $150 million will result from the tie-up. The combination also improves Men's Wearhouse's position in the industry, making it the fourth-largest men's apparel retailer and giving it a larger presence in the casualwear category, an area of strength for Jos. A Bank through its popular Traveler brand. However, given Jos. A Bank's similar top-line struggles in fiscal 2013, the acquisition seems to do little to enhance the overall growth trajectory of Men's Wearhouse, a necessary ingredient for higher shareholder value.
A better way to go
Ironically, Jos. A Bank had the right idea with its proposed acquisition of Eddie Bauer, a purchase that would have greatly diversified both its customer base and its product depth, adding major positions in outerwear, sportswear, and kidswear. Unfortunately, that deal never had a chance with Jos. A Bank's shareholder base seemingly predisposed to a tie-up with Men's Wearhouse, a deal which provided the certainty of an all-cash offer.
New investors, though, should probably take a cue from Jos. A Bank's aborted strategy and pass on Men's Wearhouse in favor of a company with a better position in the casualwear space, like Oxford Industries (NYSE:OXM). Like Men's Wearhouse and Jos. A Bank, Oxford Industries has roots in the tailored clothing business, a segment that it participates in through its Lanier Clothes unit. Fortunately, though, management wisely diversified into the casualwear space long ago, where it has acquired up-and-coming brands like Tommy Bahama and Lilly Pulitzer.
Today, these two brands account for the majority of Oxford Industries' sales (roughly 79%), and they have powered a multi-year growth trajectory for the company. At the same time, the company has maintained a major position in the tailored clothing segment for a continued source of profits that allows it to capitalize on any rebound in consumer demand for tailored clothing.
The bottom line
Men's Wearhouse won its takeover battle but now it must figure out how to generate growth from its enhanced position in a declining industry segment, not an easy task. Given the company's stock price run-up over the past year, much of Men's Wearhouse's merger story is likely baked into its current valuation and prudent investors should probably keep this suit maker on the shelf.