In the last year or so, there's been a lot of "meh" in the business of men's wear in North America. Sales are tepid, with the major North American retailers running significant promotions to keep the cash registers ringing.
You'd never know it from the performances put in by the shares in Men's Wearhouse Inc. and Jos. A. Bank Clothiers Inc., though. The two have been locked in a back-and-forth takeover drama for months, culminating this week in Men's Wearhouse buying Jos. A. Bank at a price nearly 70 per cent above Jos. A. Bank's levels of last summer. Men's Wearhouse shares have doubled over the same period.
This was not quite what I expected when I looked at the two stocks in this space in June, 2013. Men's Wearhouse had just sacked founder/spokesman George Zimmer and said it had no interest in a sale. That, coupled with its underwhelming results (particularly at its Canadian chain Moores Clothing) made its shares an unlikely candidate for appreciation.
Jos. A. Bank, I argued, seemed like an interesting long-term bet because of its mountain of cash and the prospects of the company turning around its business and scaling back its corrosive buy-one-get-three-free pricing promotions.
So, maybe the column was half right. Or all wrong, since it was hard to foresee Jos. A. Bank offering to buy Men's Wearhouse, then Men's Wearhouse turning from prey to predator.
But today's question is whether Men's Wearhouse can deliver on its greatly appreciated share price – particularly since its business doesn't seem to be a whole lot better than it was last summer.
Generally overlooked in the deal buzz this week was Men's Wearhouse's big earnings miss. Analysts expected a loss of 13 cents (U.S.) a share, says Betty Chen of Mizuho Securities USA Inc., but the company lost 38 cents per share instead. Ms. Chen expected same-store sales gains of 5 per cent at the Men's Wearhouse chain and 4 per cent at Moores in Canada, but the company reported declines of 3 per cent and 3.4 per cent, respectively.
With the chain's diluted earnings per share of $1.70 over the prior 12 months, according to Standard & Poor's Capital IQ, Wednesday's closing price of $55.69 puts its trailing price-to-earnings ratio comfortably above 30. That's growth-stock territory, which is an odd place to be, considering revenues were down 0.6 per cent from the prior fiscal year.
Of course, it's all about the future – and the expectations that the addition of Jos. A. Bank will be highly accretive to the company's earnings. And, certainly, profits should rise. But by how much?
By the math of analyst Richard E. Jaffe of Stifel Nicolaus, not enough to justify significant gains in the shares from here. He assumes no fundamental improvement at either business in 2014 and $125-million in cost savings from the deal. He derives $3.15 in EPS for 2014 and $3.69 for 2015 – meaning that at Tuesday's close of $58.01, the shares traded at 18 times the 2014 estimate and 16 times the 2015 forecast.
"We are intrigued by the tremendous earnings leverage of these businesses, the market share the combined entity will possess, and the potential synergies to be achieved," says Mr. Jaffe, who has a "hold" rating and no target price. "However, the current valuation assumes that much of this will be realized on a timely basis, which suggests to us that the shares are nearly fully valued."
Can the shares surprise once again? Perhaps if Men's Wearhouse announces a more aggressive cost-savings target. (The company plans to keep both names open and hasn't put any number on store closings.)
Or, perhaps, if everything goes right. Analyst David Mann of Johnson Rice & Co. LLC, the sole analyst with a "buy" rating on Men's Wearhouse at this price, sees revenue gains of 4 per cent or more in each of the next three years. He forecasts $4.14 in 2015 EPS and says the company can top $6 in 2016 EPS if it can achieve $150-million in cost savings. Put a mid-teens multiple on that, he says, and you can see a gain of 50 per cent from today's levels.
Fair enough. Investors might not want to count on the stock remaining so fashionable, though.