Is a Leaner Men's Wearhouse a Buy Today?


Specialty retailer Men's Wearhouse likes the way it looks without its K&G unit -- I guarantee it. The company owns a few different brands, from the eponymous chain with 638 locations to the 120-count Moore's Clothing for Men's brand. The worst of them is undoubtedly K&G, which has helped create a chart for the company that looks like a topographic map of the Himalayas. Now exploring a sale of the unit, is Men's Warehouse a more attractive investment? Let's take a closer look at the suit-maker to determine if thinner is better.

K&G: The business
The company's K&G stores were created to offer lower price-point items that appeal to a wider consumer base, including women. Though these stores number far fewer than the main chain, they are an average of 24,000 square feet per location and represent nearly a third of the company's overall retail space. In the company's most recent quarter, K&G same-store sales sank more than 5%, while the main line performed quite well. Clearly, K&G is the company's ball and chain -- and it's a heavy one.

It should come as no surprise, then, that Men's Wearhouse management announced that it has enlisted investment bank Jefferies to shop the chain to potential buyers. The sale would be an interesting move for a couple of reasons. For one, it would give Men's Wearhouse an even stronger balance sheet, which currently consists of $125 million in cash and zero long-term debt. The added cash would give the company plenty to invest in further expansion of its core, growing lines and easily increase top-line sales figures. Psychologically, it would allow investors and analysts to see a business with growing comparable-sales figures, a heavily fortified balance sheet, and an effective management team that works for the shareholders.

First things first
Taking a look at the company's latest earnings release, things looked topsy-turvy. On a full-year basis, EPS grew from $2.30 to $2.55 per share -- respectable growth given the economic climate and the company's unanticipated major volume drop in early November. The core line, Men's Wearhouse, accounted for 61% of fourth-quarter sales and grew 9.1% over the year-ago quarter. Comparables grew 1 point. K&G accounted for 16% of sales and experienced a 5.7% decline in comparable-store sales.

K&G is forecasted to shrink its contribution ratio to 13% in the coming year and experience same-store sales declines of 3%-4%. Meanwhile, Men's Wearhouse is targeted to grow 4%-5%, with Men's Wearhouse Tux Rentals growing 5%-6%. Moore's, the Canadian line that had a decline in comps for the fourth quarter, is forecasted to grow 1%-2% and contribute 11% to the parent's earnings.

K&G stumbled during the financial crisis, and it has not yet been able to recover. Management is wise in trying to unload it.

Currently, Men's Wearhouse trades at one-year forward P/E of 11.44, assuming $2.75 in full-year EPS. Management guided anywhere from $2.70 to $2.80 per share, which would represent a 7% to 11% increase from the recently ended year's $2.55, when adjusted for the 53rd week. The company generated nearly $71 million in free cash flow, or $1.40 in FCF/share. That's a P/FCF ratio of 24.26.

For a comparison, look at Jos. A. Bank Clothiers . The company trades at over 13 times forward earnings and recently cut its earnings estimates. It generated $54.3 million, or $1.94 per share and a P/FCF multiple of 21.7.

The call
If Men's Wearhouse can shed K&G at a fair price, rent expenses should come way down and free up more cash flow, then warranting stronger valuation multiples to its closest competitor, Jos. A Bank. The company will invest in more core stores toward its 750-store goal, which should prove to be competent capital allocation given comparable-stores growth.

Men's Wearhouse faces increasing competition from Jos. A. Bank as it attempts to rapidly increase store count and achieve operating scale. Department stores such as Macy's also present competition, though the company has navigated this traditional retailer well in the past.

With a management team that seems to be wise capital allocators in a strong core brand, Men's Wearhouse may be a good play over the next two to three years and at today's price. While valuation may be on the low end, it's not quite enough to warrant a strong buy given its downside risk. Investors should keep a close eye on the company's effort to sell K&G and the subsequent performance.

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