In early 2016, credit spreads were hitting the widest levels in years, and Tailored Brands Inc. (NYSE:TLRD) was deep in the midst of botching its ill-conceived acquisition of Jos A Banks ("JOSB"). The company had $1.7 billion of debt trading at distressed levels, and it was levered at >5x EBITDA, based on my conservative estimate of 2016 EBITDA at that time. Fast forward to today, and TLRD's leverage is ~3.1x EBITDA, and most importantly, the Company has generated $570 million of cash flow and paid down $460 million of debt, much of which was retired below par. However, TLRD's market capitalization today is only $390 million above its level in February 2016. Put another way, TLRD's current 6x EBITDA multiple and 16% FCF yield is a discount to its trough valuation in February 2016.
In every way, TLRD is a better company with a better balance sheet than it was in February 2016. The Russell 2000 is up 60% since then. However, TLRD's valuation and its stock's volatility continue to reflect its checkered past, as if the past 2.5 years didn't happen. Its most junior debt yields 6.8%, but its equity yields 16%. This is a glaring disconnect, which I have seen play out very well for the equity in other situations.
This is a stable, growing, and highly cash generative business without the seasonality, fashion trends, or secular threats that are characteristics of most other apparel retailers. Based on a more appropriate 7.5x 2019 EBITDA and 9% FCF yield, TLRD is worth $40 per share (+90% upside). I believe TLRD's continued operational execution, ongoing improvements in JOSB, and capital returns will drive upside in the stock, particularly given TLRD's 30% short interest.
Why does this opportunity exist?
- The equity market still thinks TLRD is a distressed credit - but all of TLRD's debt trades above par now.
- It has lost its following and has little equity sell-side coverage - only Deutsche Bank and Jefferies. It still gets more coverage from credit analysts than from equity.
- Investors fail to distinguish TLRD versus more secularly challenged brick and mortar retail. The competitive and demand dynamics for TLRD are completely different than for department stores and mall-based retail.
- Asset allocators are not TLRD's customers, and therefore the business model is fundamentally misunderstood by the $2k-suit crowd. In the MW banner, TLRD's core customer is a 20-something male who has never purchased a suit before. The in-store wardrobe consultant is a commission-based salesperson who helps put together a complete starter wardrobe for the customer. The customer comes in to purchase his first suit, and TLRD can send him out the door with 1-2 suits, shirts, shoes, and accessories. Now, that customer is a repeat patron until/unless they upgrade themselves to the $2k-suit socioeconomic class.
- Investors think online made-to-measure suit start-ups can disrupt TLRD. They can't. Online-only made-to-measure is a fundamentally flawed business model. There is no digital or DIY solution that can replicate an in-store fitting. The lead times for that business model are long, and the return rates (i.e., suit doesn't fit appropriately and so the customer sends it back) are prohibitively high. TLRD's custom suit business can deliver a higher quality product with much faster delivery, and TLRD has an uncontested nationwide market presence through its brick and mortar stores (a store within 10 miles of 70% of all men in US and Canada).
History & Situation Overview
In the spring of 2013, TLRD's stock traded in the low-$30s at less than 6x EBITDA and a ~9% unlevered FCF yield. The Company's balance sheet was clean, with no debt and over $150 million of cash. The stock was offering exceptional value for a business that is uniquely stable and resilient in the retail apparel industry, without the fashion trend risks and seasonality that characterizes most of its department store and other retail peers. Additionally, TLRD was a uniquely attractive acquisition target given these business attributes, as well as its unlevered balance sheet and flush cash position. The stock was an attractive long.
Several months later, it appeared that the intrinsic value of TLRD would be catalyzed, as reports hit that JOSB was seeking to acquire TLRD for $48 per share in cash (just under 8x EBITDA). These reports were substantiated shortly thereafter, and TLRD traded into the mid-$40s. However, it quickly became clear that TLRD management had no interest in selling out to its smaller competitor. What ensued was a somewhat bazaar dance between TRLD and JOSB where each topped the others bid, in an attempt to be the 'victor' who absorbed the other (rather than being absorbed). Ultimately, TLRD emerged the higher bidder and acquired JOSB for $65 per share in cash. The deal closed in June 2014 and was financed with $1.7 billion of debt, encumbering TLRD's previously unlevered balance sheet.
With the acquisition complete, TLRD became a popular hedge fund stock. Management's synergy projections and overly optimistic long-term EPS targets propelled the stock to over $60 per share briefly in June 2015. However, it subsequently sold off to $40 per share by November 2015, as performance at the JOSB business disappointed. Then in November, TLRD preannounced a 3Q'15 miss and reported that comparable sales growth ("SSS") at JOSB was down -15% and forecast to be down 20-25% in 4Q. This alarming indication that the JOSB acquisition was proving to be a flawed construct sent the stock down over -40% in one day, and it sold off further in December when management reported that JOSB's SSS continued to accelerate to the downside, now looking to be down ~35% in the 4Q. The stock bottomed in Feb 2016, down over -80% since it peaked in June.
The downward re-rating of TLRD's stock in November 2015 was accompanied by a precipitous drop in its Senior Notes. These Senior Notes had previously been trading well above par, but cracked and fell to the high-70s by the end of November, before falling further to the 60s by January 2016. Management committed to reducing leverage as they executed a turnaround and store rationalization for the JOSB banner. This turnaround has been largely successful, and TLRD has repaid or repurchased nearly one-third of its debt, much at levels below par.
Since 2016, the Company has successfully executed its rationalization of unprofitable stores, primarily in the JOSB banner. JOSB stores have been reduced from 625 to 487. MW Tux stores have been reduced from 160 to 49, as these stores are consolidated within larger format MW banners stores. Store counts for the MW, Moores, and K&G banners are stable (up slightly) since then. Today, TLRD has 1469 locations, 49% MW / 33% JOSB / 9% Moores / 6% K&G. Its retail revenue is 57% MW / 24% JOSB / 11% K&G / 7% Moores.
Comparable sales growth has trended +LSD%, while both GM% and EBITDA margins are stable. Management noted an acceleration in trends coming out of 2Q and increased its comp growth for the year. With modest capex needs and declining interest (from debt paydown), cash flow conversion is nearly 50%. Furthermore, TLRD continues to reduce inventory and has been able to take substantial cash out of working capital over the past several quarters.
The JOSB banner, which was in steep decline in 2015 (-16% SSS) and 2016 (-9.5%) following its acquisition by TLRD, has stabilized and partially rebounded (+5.4% in 2017 and +LSD this year). However, it's earnings contribution remains minimal despite being a $135 million EBITDA business prior to being acquired by TLRD. The rationalization of unprofitable stores is largely complete, but there will be some continued benefit as certain leases roll off in coming quarters. A return to more substantial profitability is upside optionality.
TLRD's key growth initiative currently is in its custom suit business. Custom is higher average price ("ASP") and higher EBIT dollars versus rental or off-the-rack. This business is run-rating at $4 million per week, versus $2 million per week in 2017. There is a growing preference by customers to purchase a custom suit or tux, rather than rent or purchase off-the-rack. Custom suit purchasers register higher satisfaction ratings, shop more frequently, and have a higher annual spend than off-the-rack customers. Custom currently accounts for ~20% of TLRD suit sales, but top performing stores have achieved over 50% penetration for custom. TLRD can offer standard 3-4 week delivery on the most popular price tiers for custom suits. Premium custom suits are manufactured domestically and can be delivered in two weeks. This is well below the 2-3 month lead times that are common for made-to-measure custom suit product by smaller competitors. They are also rolling out a "Custom Express" offering that can deliver a custom suit in 7 days. Custom Express will be rolled out to all banners in 3Q.
Recently, Doug Ewert retired as CEO, and Executive Chairman Dinesh Lathi stepped in to run the Company as the CEO search is underway. Dinesh has operational experience and has been with the company for 2.5 years. Doug Ewert joined as CEO in 2011 and wrested control of the Company away from its founder, George Zimmer, in 2013. He oversaw the calamitous acquisition of JOSB, and Doug is generally viewed with ambivalence by the investor community. His departure will likely prove to be a neutral or positive event for the Company.
TLRD operates the largest national chain of tailored clothing retail stores, including. The Men's Wearhouse banner stores cater primarily to males age 18-35, and offer tailored suits and sports coats, as well a casual assortment, outerwear, shoes, and accessories. Essentially, Men's Wearhouse is a one-stop shop for customers looking to purchase (for the first time) or supplement their formal and/or business casual wardrobe. The store layout is open and organized, and sales employees are trained as consultants, to assist customer is establishing an entire wardrobe (suit, shirts, shoes, accessories, etc.). The sales approach focuses on outfitting the customer with everything they need to "like the way they look" for business and formal occasions. Men's Wearhouse stores also operate a lucrative tuxedo rental business, serving grooms, groomsmen, and prom-goers.
TLRD's Tux Shops were acquired through the purchase of After Hours from Federated Department Stores (now, Macy's) in 2006. The Tux Shops are smaller format, mall-based stores primarily focused on tuxedo rentals. Over the past several years, management has been methodically closing, relocating, and rebranding Tux Shops under the larger format Men's Wearhouse banner. This strategy has allowed TLRD to grow total square feet and sales per square foot, even as the number of total Men's Wearhouse and Tux Shop stores has actually been slowly declining.
The JOSB banner targets an older demographic of career professionals ages 35-60, with an assortment of tailored suits and sports coats, as well as casual wear, outerwear, shoes, and accessories. JOSB stores are primarily located in regional malls and lifestyle centers. Its average store size is about 80% of a Men's Wearhouse banner store's square footage. Moore's is a concept similar to the Men's Wearhouse banner, but it operates in Canada. K&G is a more value-oriented superstore format that targets a price sensitive consumer. In addition to the retail banners, TLRD's corporate segment ("Corporate") provides work apparel to businesses in the US and UK.
TLRD's legacy businesses (excluding JOSB) have proven remarkably stable since the 2008/09 recession, against the backdrop of volatility in the broader apparel marketplace. SSS for Men's Wearhouse bounced back in 2010-11 and have grown at a low single-digit % rate since then. Clothing and total gross margins for the legacy businesses, excluding JOSB, have been holding steady.
Operational struggles have largely been isolated to JOSB. For much of its history, JOSB was a fast-growing mall-based concept generating high single-digit % SSS and expanding its store count by 5-10% per year. In 2012, JOSB began to face headwinds as its marketing approach began to lose traction with consumers and higher costs pressured margins. TLRD acquired JOSB (in 2014) with the intent to make significant changes to the marketing, procurement, and merchandising approach at the stores. The goal was to grow margins while preserving JOSB's ~$1 billion in revenue. I believe TLRD may have gone too far in its sweeping changes at JOSB, as the top-line came under pressure immediately after the acquisition closed. However, it wasn't until 3Q'15 when management terminated JOSB's buy-one-get-3 ("BOGO3") promotion that sales turned down significantly.
TLRD saw the overly aggressive BOGO promotions of JOSB as short-sighted and a "cancer" for the business. While the eye-catching nature of BOGO3 drove traffic into the store, TLRD management believes that it had the negative impacts of pulling sales forward, cheapening the JOSB brand, and forcing customers to buy more suits than they desired to own. By replacing BOGO3 (which amounts to a 75% discount on suits) with slightly less extreme (~70%) discounts on single suits, TLRD management hoped they could grow clothing margins and gross profit even as the top-line may decline somewhat. While clothing margins have improved, the unexpected and extreme fall-off in JOSB's sales resulted in meaningfully lower gross profit and EBITDA. Essentially, the deleverage of falling sales against occupancy costs (included in COGS) were only partially offset by higher clothing margins and improving tuxedo margins (the result of TLRD bringing JOSB's tuxedo rental business in-house).
Throughout the turnaround of JOSB, management has been working to calibrate the appropriate marketing and promotional strategy to replace BOGO3, but JOSB has yet to return to its prior profitability. The business has been rationalized and is not losing money, but there is still significant upside optionality from earnings growth in the JOSB banner.
Below I summarize TLRD's current valuation and capitalization. I have included its capitalization from early 2016 as well, to illustrate how much has changed since then.
TLRD is a stable and highly cash generative business. Its stock's high-teens FCF yield reflects a glaring disconnect from the fundamentals and the yield on its bonds. Current levels offer significant upside from multiple expansion and FCF, used for further deleveraging and capital returns. Based on 7.5x 2019 EBITDA and 9% FCF yield, TLRD is worth $40 per share (+90% upside). Furthermore, TLRD has upside optionality from a return to profitability in the JOSB business. It also represents an attractive take-private candidate for a private equity sponsor, given its stable and robust cash flow. Dinesh has a background in private equity, and it is not unthinkable that he may use this opportunity (management transition) to take the company private.
Disclaimer: Do not rely on the information set forth in this write-up as the basis upon which you make an investment decision - please do your own work. The author and his family, friends, employer, and/or funds in which he is invested may hold positions in and/or trade, from time to time, any of the securities mentioned in this write-up. This write-up does not purport to be complete on the topics addressed, and the author takes no responsibility to update this write-up in the future.
Disclosure: I am/we are long TLRD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.