Jos. A. Bank Clothiers - You Can Have Too Many Suits

| About: Jos. A. (JOSB)

By Naveen Reddy and Damion Rallis

They say a woman can never have too many shoes. Joseph A. Bank (JOSB) thinks the same about its suits for men. Particularly on the east coast, the company has become famous for indiscriminately carpet bombing their ads across multiple media outlets. Whether sitting down to watch a football game, opening the mail or driving in the car listening to the local news, every man woman and child in earshot has been exposed to the company's never ending two for the price of one suit sale. At first glance, the shares look like a good deal, given that revenue has grown steadily since 2008 and the forward P/E is below 10. However on closer examination the stock, like the suits, may not be the bargain that it appears to be on paper.

Jos. A Bank stock has taken a roughly 25% tumble from a recent high of $54.48 in March 2012. The stock previously exceeded this level, hitting all-time highs in both May 2011 and October 2011, and then promptly falling about 18% each time. If one was able to ride out the intermediate term volatility, both dips offered attractive entry points as the stock rebounded decisively. Most impressively, in the last 10 years Jos. A Bank has returned 913% vs 137% against its bench mark index the S&P 600 Small Cap. But with any retail story, the good times eventually come to an end, as the concept gets saturated and same store growth slows. While Jos. A Bank does not trade with a P/E in rarefied territory such as recent fallen star Chipotle Mexican Grill, GMI Ratings feels that the current crosscurrents between the company's accounting, strategic and governance issues pose a material risk to Jos. A Bank investors.

As of June 2012, Jos. A Bank had an Accounting and Governance Risk (AGR®) score of 18, placing it in the 18th percentile of all companies GMI Ratings covers and signaling a higher likelihood of a negative accounting event in the next year. The AGR dipped into Aggressive range back in June 2011 and has shown a decline ever since. Flags for Inventory/Cost of Goods Sold have been persistent and have increased in recent quarters. This comports with the observation that finished goods inventories are on the rise, which could lead to further discounting activities. The company has also had a consistently high Operating Revenue/Operating Expense ratio. Both metrics are indicative of potential revenue recognition issues. Jos. A Bank has had consistently high Prepaid Expense/Operating Expense and consistently low Cost of Goods Sold/Revenue ratios. Both are indicators of expense recognition problems. The company has also had a steadily declining rate of asset turnover relative to its industry since August 2009 which is a sign of potential problems in the efficiency of its operations.

These accounting issues amplify the concerns over Jos. A Bank's strategy and its position in the marketplace. While it is clear that a suit that is consistently priced at 50% off is not meant to compete in the same league as Hugo Boss or Gucci, it appears that Jos. A Bank continues to whittle away any of its remaining quality premium. It has upped the ante and recently offered a "three suits for the price of one" promotion. Implicit in the constant discounting is a loss of pricing power, as the Jos. A Bank customer has been conditioned to always expect a deal. If sales drop, the company does not have the ability to leverage margins to maintain its earnings power.

For most men, the thought of a well-priced suit that does not look cheap is compelling at some level; given that suits are essentially a necessity akin to toilet paper or laundry detergent. Diminishing marginal utility is the result of the underlying nature of men's suits. Unlike women's clothing, whether high end or fast fashion, articles of clothing are emotionally and psychically consumable. Men's suits don't have the same sway. Unless working as a lawyer, on Wall Street or in sales, most men, buy a suit, stick it in the closet and forget about it until they need to attend a wedding or other special event. Simply put, once men buy a suit or multiple suits, the ongoing replacement rate is very low.

Larger trends also point to potential distress in the Jos. A Bank business model. The U.S. job market has been stuck in neutral since 2008. A job seeker who has landed a number of interviews would be the likely target to buy two suits or even three for the price of one. The reality is that the U.S. job market does not seem to be at any sort of inflection point that would indicate a sustained upturn. More troubling is the fact that many of the professions that would hold the target Jos. A Bank customers are being disrupted. Nationally, the legal profession is being gutted at both the high and low end of its ranks, with lawyers either being by replaced by technology or simply being priced out of the market. Wall Street bankers are not the only financial professionals at risk. A higher incidence of mid-level finance and accounting work is being outsourced, as many of these jobs can be performed more cheaply overseas. Again the traditional bastions of suit-wearing professionals are diminishing. Also significant is the unstoppable trend toward casual dress at the work place. Fewer men wear suits if they don't have to, simply because of the cost of dry cleaning and maintenance. Younger men will generally opt towards business casual or even a nice shirt with jeans, if they can get away with it.

Another piece of the picture, and one that is ignored by most analysts but of ever-increasing importance, is the company's governance. The Jos. A Bank board is hardly equipped to make bold strategic decisions. The company has a relatively small board of only six directors, which has the potential for a few key individuals to wield disproportionate influence. In fact, half of the board at one point has served as CEO at the company. Along with Current CEO R. Neal Black, Chairman Robert N. Wildrick served as CEO from November 1999 to December 2008, while Lead Independent Director Andrew A. Giordano served as interim CEO from May 1999 to October 1999.

Additionally, Mr. Giordano and Mr. Wildrick have both served for almost two decades, while Sidney Ritman and Mr. Giordano are almost 80 years old, indicating a lack of succession planning. Though there is value in experience, long-tenured directors can often form relationships that may compromise their independence and reduce their effectiveness. To highlight the considerable influence of Mr. Wildrick, his consulting agreement extends to January 2014 and pays him $825,000 for matters related to strategic planning and initiatives. In total, he received $1,148,730 in fiscal 2011 total summary compensation. No other named executive officer other than the CEO received a higher amount of total summary compensation for that year.

The opportunity for outsiders to agitate for change is also diminished by the company's takeover defenses. The board's classified structure makes it more difficult and lengthy for outside interests to gain control of a majority of the board. Additionally, the poison pill - which makes unwanted takeover attempts particularly onerous on the acquirer - was not approved by shareholders, and is not due to expire until 2017. The dangers are manifest. This is an aging board set on cruise control with a tired and unimaginative discounting strategy. It is insulated by takeover defenses and has tasked the almost 80-year-old Chairman conceptualizing market beating strategic shifts.

Currently, Jos. A Bank is sitting near its 52-week lows. The last time the stock visited this area in early 2011, shares rose 42% to an all-time high by May 31, 2011. For new investors the question is whether or not this is a buying opportunity, and for existing investors whether or not they should ride out the volatility. For the time being, Jos. A Bank's reported short ratio as of July 13, 2012 is 15.3 and its shares short as a percentage of float is 23.4%. These are very high numbers and indicate that there is a large number of traders who believe the share price will decline from here. For the time being, the large aggregate short position should provide a floor to the share price and could result in a short squeeze should the company report any good news. Unlike other clothing retailers, Jos. A Bank is not subject to the fashion-driven whims of an image conscious customer. However, longer term, the sum of the accounting, strategic and governance warning signs point to a slow moving train wreck.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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