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Suits Me

(Guest Commentary by Rick Konrad – February 21, 2008)

Dear Subscribers and Readers,

For those who had wanted to learn more about picking stocks, evaluating companies, and other issues related to the stock market, we have again brought in one of our regular guest commentators, Mr. Rick Konrad for a guest commentary.  Rick is one of our two regular guest commentators (besides Bill Rempel) and usually writes for us every third Wednesday of the month.

In this commentary, Rick will be offering his thoughts on a premier stock in the menswear apparel industry: The Men's Wearhouse.  In a way, this is an extension of his January 17th guest commentary on various “plays” in the consumer discretionary sector, especially the retail industry (the bargains simply keep on piling in the industry – note that these are very far from being so-called “value traps”).  Without further ado, following is a biography of Rick:

Rick is author of the excellent investment blog “Value Discipline,” founder of “Value Architects Asset Management”, and is a regular guest commentator of MarketThoughts (please see “The Value in Uncertainty” for his last guest commentary).  Prior to his current role, Rick has been a professional portfolio manager for institutional investors for over 25 years.  You can view a more complete profile of Rick on his blog and should you have any questions or thoughts for Rick after reading his commentary, you can also email him at the following address.  Rick is a very genuine teacher of the financial markets and treats it very seriously.  Case in point: Rick has also been responsible for running the education program for the CFA Society in Toronto (which is the third largest CFA society in the world besides the New York and London Societies) and had also been responsible for grading CFA papers.

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.

Menswear retailing seems to be intuitively appealing, given the moderate amount of fashion risk. Consequently, inventory problems due to fashion mistakes and misjudgments should be de minimus. Nevertheless, as stocks, menswear apparel has been through the grinder much like other retailers. The Men's Wearhouse (MW) is down about 47% in the last 52 weeks, Joseph A Bank Clothiers (JOSB) is down 26%, Sym's (SYM) is down 43%, and Casual Male (CMRG) is down 68%. I would like to focus on MW largely because of its history of cash flow generation and superior profitability.

The Men's Wearhouse is one of the largest specialty retailers of men's suits and apparel in the US and Canada. In the US, it operates in 45 states and DC under the brand names Men's Wearhouse and K&G Fashion Superstores. In Canada, it operates 116 retail stores in all 10 provinces under the brand name Moore's Clothing for men.

The Men's Wearhouse with over 600 stores, targets middle class and upper middle income men with quality merchandise at everyday low prices. Customer service also plays an important role. The inventory mix includes business casual merchandise, which consists of tailored and non-tailored clothing (such as sport coats, casual slacks, knits and woven sports shirts, sweaters and casual shoes) that complements its existing product mix. Brand name and private-label merchandise is offered at 20 to 30 percent below regular prices at traditional department stores.

K&G targets more price-sensitive shoppers and operates 93 stores in 27 states. Many of the K&G stores offer women's career apparel as well. Discounts in this division tend to reach down to the 50% level.

Finally, newly acquired (April 2007)After Hours is the largest men's formalwear chain in the United States and operates 507 stores in 35 states under After Hours Formalwear and Mr. Tux store fronts. After Hours has an exclusive relationship with David's Bridal, Inc., the nation's largest bridal retailer with 269 stores and an online offering. That exclusivity is also being extended to Men's Wearhouse and Moores store brands.

Moore's brand in Canada also targets its middle income customers with everyday low price offerings. Moore's has manufacturing capabilities through its Golden Brand Clothing facility that manufactures not only for Moore's but also for Men's Wearhouse.

MW has generated free cash flow every year in the last decade except in 2002. The operating cushion (gross margin less S,G, & A ex depreciation) has expanded to 16% in the most recent fiscal year from levels of about 10% for most of the last ten years.

Here is a look at the cash flow drivers for the last ten years:

The valuation of these menswear retailers on an Enterprise Value / EBITDA  basis (using trailing twelve months EBITDA) demonstrates how little the market cares about this sector at the moment:
















Here is a spreadsheet of MW's statement of cash flows since 2000:

As you can see, every year operating cash flow has exceeded net income. Operating cash flow has totaled $928 million and capex has represented just over $500 million. In fact, the store count has more than doubled over the last five years. Despite that aggressive growth, the company has returned $318 million to shareholders through buybacks (net of options issuance, a net return of $251 million). The share count is down to 53 million shares, versus 61 million five years ago.

Long term debt to assets is about 7%. Cash on the balance sheet exceeds debt.

For the past three years, return on equity has climbed to high teens levels from historic levels of about 10%.

In terms of profitability, MW does lead the pack. Looking at ROA for the last twelve months MW earned 22.8%, JOSB at 21.6%, SYM at 2.23%, and CMRG at merely 5.1%.

Looks like good historic profitability relative to a cheap valuation. Why so cheap? In January, the company lowered guidance: Sees FY07 EPS $2.60-$2.62 down from prior $2.87-$2.92 vs. consensus of $2.90. The company anticipated continued weak traffic trends for January. So short-term, a little grim and disappointing, long term, this has been a first class retailer.

The addition of After Hours could well further transform the company through improved merchandise mix and higher margin tuxedo rental.

In summary, the stock seems to be discounting long term misery. Insiders have started to buy at these levels and below in 2008. They had been sellers all through last year mostly in the high $40's and low $50's. Insiders hold about 9% of the company.

In short, I like the stock at current levels. I can't resist…suits me fine.

Disclaimer: I, my family, and clients do not own a current position in any of the securities mentioned.

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