Jos. A. Bank Clothiers (JOSB) has multiple initiatives to drive growth for years and to transition to higher margin products. I feel that due to these initiatives and growth potential, JOSB is currently undervalued at a forward PE of 14x. The push toward higher margin products is necessary due to the recent appreciation in input costs such as cotton and wool.
- The shift to higher margin products will take place in the tuxedo rental, Big & Tall and the tailored clothing segments, with the goal to move margins higher than the 10% they are today.
- Brick & mortar and ecommerce expansion plans include driving traffic to international ecommerce sites and adding 40 to 50 new brick & mortar stores.
- The surge in commodity prices affects JOSB’s margins as cotton stayed at its all time highs and didn’t dip below $120/lbs for the entirety of Q2. These prices could pressure JOSB’s profitability.
- Using 5-year-high valuations for F P/E, PB, and PS and a PEG ratio of 1, I feel that a fair 12-month price for JOSB is $58, a 13% premium to where it currently trades.
Higher Margin Products
During the last conference call management shared plans for a drive in higher margin products such as tuxedo rental, Big & Tall sales and tailored clothing (suits) sales. In terms of tuxedo rental, JOSB plans on accruing its own inventory of tuxedos meant for rental. This would increase the segment’s margins, as tuxedos can essentially be recycled from season to season. Big & Tall products have higher margins because the incremental increase in cost of production is more than offset by their higher prices. Tailored suits carry more margin due to the services associated with custom tailoring. Another added benefit of tailored suits is a transition to a younger customer as modern style shifts to a more fitted and slim look.
Brick & Mortar and Ecommerce Expansion
Management laid out plans for 40 to 50 additional brick & mortar stores for 2011, with 9 already added in Q1. This plan to add more stores will continue to feed organic growth as the company penetrates new markets and locations. Even though the company is adding new stores, same store sales grew by 7% in Q1, showing that continued expansion is still healthy.
Ecommerce is a big profitability driver for retail companies, as the sales for entire countries can be run from one site rather than needing to add new physical stores. Naturally this decreases capital expenditure and therefore increases JOSB’s return on capital. This is why international ecommerce has been such a big part of JOSB’s expansion plans. In fact, it has been driving traffic to its sites through marketing tactics, such as online promotions that offer discounts only to online shoppers. As of Q1 JOSB was shipping to 30 countries.
For the entirety of Q1 cotton futures stayed above $120 and just recently fell back down to $100. In order to save margins, JOSB raised prices on its sporting apparel line and surprisingly consumers didn’t react negatively as sales continued to grow. The push into higher margin products should have cushioned the blow from higher prices but they still caused margins to be lower than they would otherwise be. As the commodity prices come down (a trend that has already started) we should see impressive margin expansion and higher-than-expected returns.
The real influence of the tuxedo rental segment will become clear during the next conference call. The biggest season for tuxedo rental is wedding season, which is from the spring to fall, covering most of Q2. This will be a very important part of the call to listen to if this segment of the growth potential I outlined before is actually going to happen.
The spike in inventory last quarter should actually give investors confidence due to the positive reasons. Management explained during the last call that this occurred because higher-than-expected sales in 4Q10 drove inventory to lower levels than normal. This caused the company to buy more than usual to replenish inventory levels, but due to higher costs the same inventory cost more. Another reason is management is expecting higher sales due to a higher store count and further ecommerce success.
Valuation and Price Target
Due to how publicized JOSB’s growth potential is I didn’t want to let the valuation run away from its expected growth so I used a PEG ratio of 1. Due to how this is one of the strongest growth environments for JOSB in 5 years I used the 5-year highs for all the other valuations (F PE, PB, PS). The 5-year highs for these metrics are 16, 3.5, and 1.8 respectively. The price target for a PEG ratio of 1 is $54.3, the price target for F PE is $57.92, the price target for PB is $63.49, and the price target for PS is $56.89. The average of these price targets is $58, a 13% premium to where JOSB currently trades. If all the growth initiatives occurred as planned and the cost of cotton had less of an impact than expected, then the shares could be worth much more than my price target.