Geoff Gannon June 23, 2019

Tailored Brands (TLRD): Operating at the Focal-Point of the Retail Apocalypse and the Hedge Fund Armageddon, TLRD is a Stable Company With a P/E of 3

by JONATHAN DANIELSON

 

Tailored Brands is the company behind the brand names Men’s Wearhouse (MW) and Jos. A Bank (JOSB). As you can probably guess, Tailored Brands operates in the specialty retail industry. More specifically, they provide the younger-to-older middle-class male demographic with suitwear. Broadly speaking, their portfolio of clothing includes suits, sport coats, slacks, business casual, outerwear, dress shirts, shoes and accessories.

 

I don’t want readers to be misled by the title of this article since I labeled the company as “stable”: Tailored Brands is a high-risk stock. I classify Tailored Brands as a stable company because if you take a look at the company’s stock chart, you’ll see that over the course of the past year TLRD is about 85% off its highs. The stock was trading at $30/share as recently as June of last year. It’s at $5/share now. With a drop that dramatic you would usually expect to find one or more of a few things going on with the company. You would probably expect sales or earnings to be down quite materially. Or you’d expect to find impending liquidity issues. But that’s not necessarily what we find here. Top-line consolidated sales since 2015 are basically flat. Operating income is up 20% since then. Whether or not these are good numbers doesn’t matter right now. At least initially, the business doesn’t seem to have fallen off a cliff; yet the stock certainly has. So why is the stock high-risk? Well, a lot of reasons. One factor that adds to the riskiness of the situation also makes the stock look cheaper. All of you reading this can probably guess what I’m referring to: leverage. Despite aggressively paying down debt over the previous few years the company is still saddled with debt that equates to 3x EBITDA. Anytime you have a business where the popular sentiment is that the business is possibly facing a secular decline (i.e. the market is not too hot about the company’s growth prospects) and you add a highly-levered balance sheet to the mix you tend to get a stock that looks ridiculously “cheap” on standard valuation metrics. These dynamics make the stock high-risk.

 

Geoff recently wrote-up Farmer Mac (Ticker: AGM) on this site. If you haven’t read that post yet, you should go do it before reading on. In his write up of the Company he said, “An investor interested in Farmer Mac should spend 95%+ of his time worrying about the risks.” And why is that? Why spend so much time pondering the risks of the stock? Because, in his case, the stock he was evaluating was far, far too cheap for the quality of the business. So the only question relevant to investors is: what are the potential catastrophic risks? Will the company survive? If the Company survives then the stock should be a homerun.

 

I think Tailored Brands is very much the same. It’s not that I’m not making the argument that a specialty retailer is an especially good business. What I am saying is that if TLRD is still trading in 5 years, it’ll almost certainly be trading higher than it is today. Probably a lot higher. And here’s why: The Company did about ~$322 million in cash flow from operations in 2018. Capital expenditures are very low in the business. They have averaged around $90 million in the past few years. So we can call free cash flow $232 million. It certainly isn’t less than $200 million, if you want to debate that a higher figure for cap-ex is correct.

 

TLRD’s market cap is $285 million.

 

You read that correctly.

 

The market cap of the business roughly approximates free cash flow. The dividend yield is close to 12%. If the business in its current form survives, the stock is far, far too cheap. On a levered basis (P/FCF), it’s trading for about what it generates in cash each year.

 

Of course, you might be inclined to point out that I just stated the business is extremely levered. And fair enough. We’ll save the in-depth discussion of valuation for later in this post, but let’s get a quick overview of what the company looks like on an enterprise basis. So if we account for the leverage in the business we get an EV/EBIT of ~5.5. As always with levered companies, on an enterprise basis the stock doesn’t look as cheap. It’s still very cheap though. Too cheap if it is going to survive.

 

So, naturally, the question becomes: Will the Business Survive?

 

The Business

 

But before we tackle the question of if the company will survive, we first have to understand the actual business. Broadly speaking, Tailored Brand as two main operational segments: The Retail Segment – where they sell the actual product (suits) and rent out the product – and the Corporate Segment where they provide both UK and US businesses with uniforms and other similar workwear apparel. The Retail segment vastly dwarfs the Corporate segment as it accounts for a little over 90% of total revenue. So we won’t be talking about the Corporate segment very much. The Retail segment includes selling tailored product (46% of retail sales), non-tailored product (32%), providing alterations (13%), and rental services (5%). The brands behind Tailored Brands include Men’s Wearhouse, Jos. A. Bank, Moores and K&G.

 

Tailored Brands is the largest provider of men’s formal attire in the United States. In total the Company has 1,464 stores. Like most specialty retailers operating today TLRD has, in aggregate, been steadily rationalizing their store base. Since 2016 total store count is down roughly 15% (~200 stores). With most of these store closures coming from Jos. A Bank and MW Tux shops as the total number of Men’s Wearhouse stores are up, albeit only slightly. As of February of 2019, the type of each store is broken down as follows: 719 Men’s Wearhouse retail apparel stores in all 50 US states, 46 Men’s Wearhouse and Tux stores in 22 states, 126 Moores retail apparel stores in 10 Canadian provinces, 88 K&G stores in 27 states, and 484 Jos. A. Bank retail apparel stores. The Company tells us all of these stores are leased.

 

Both Men’s Wearhouse and Jos. A Bank target essentially the same demographic. Management claims that Men’s Wearhouse serves a slightly younger crowd. I haven’t seen any proof of that by way of statistics, but let’s go with it for now. What they both seek to accomplish is to be the one place middle class guys can go to be suited for their formal wardrobe. Whether that’s a 25-year-old landing his first white-collar corporate job, a 50-year-old looking to add a blazer to his selection of workwear, or a teenager going on his first prom date – MW and JOSB both want their business. The sales team is trained to be very “hands-on”. They want to assist you with product knowledge and help you achieve the style you’re going for. In FY 2016, the Company introduced custom apparel for their suits at Jos. A. Bank. These products are personalized depending on what the customer selects from a variety of pre-established combinations. The option for custom apparel is available at MW and Moores as well. In 2018 sales from this segment more than doubled to $200 million. Customers typically get their merchandise in less than a month and this seems to be a growing method of choice for consumers.

 

On the rental side of the business, Management appears to be continually winding the MW Tux stores down and instead incorporating this line of business within the full-line stores. It’s not that Management is moving away from the rental business, however. Revenue from this segment in total hasn’t declined much over the past 5 years (staying at around 12% of total revenue), however the Company’s stated strategy has been to start servicing these customers through their full line stores. These stores have a smaller selection than the flagship stores as customers only have access to the more limited rental products. Most of these stores are located in regional areas and in malls. These stores are much smaller than the standard MW store, standing at roughly 25% of their counterpart’s store size as measured by square feet. Since 2014 the company has closed over 150 of these store locations, which equate to ~80% of stores. As of 2019, there are 46 stores in 22 states under the Men’s Wearhouse and Tux brand.

 

Buy One Pair Of Socks Get 7 Suits For Free!! (Or AKA some terrible advertising)

 

We’ve all seen the ads. They truly are notorious. The ads were essentially you could get 75% off of a suit. This is because you paid “full price” for one suit and you got three others for “free” (the actual promotion wasn’t get 7 suits, as far as I’m aware.). Unlike many companies we see in today’s market, Jos. A Bank (when it was a standalone entity) wasn’t hemorrhaging cash in order to scale. They just marked their initial product up tremendously. So instead of offering you 25% off of a $400 suit, they’d charge you $1000 for the first one and include three others. These ads certainly are eye-popping. The crazy thing here to me is that they actually worked pretty well – there’s got to be a mental model in here somewhere (in fact Munger has almost certainly talked about it before). Before they were acquired by MW, Jos. A Bank was a fast growing (~10%+ top-line growth yoy) little retailer generating 10%+ operating margins. People thought they were getting a great deal, and the company grew because of it.

 

What happened next is almost certainly being studied by a Harvard graduate student somewhere. We’ll coin it the most Ill-Fated Acquisition in the history of all of retail. In 2013 Men’s Wearhouse received a buyout offer from Jos. A Bank, who was a younger and smaller competitor at the time. The merger proposal turned hostile when the Board of MW promptly refuted the offer as “inadequate” and adopted a poison pill in attempts to stave off the potential acquirer.

 

To much surprise Men’s Wearhouse then countered the takeover bid with one of their own to take over the assets of Jos. A Bank. What followed was the all too familiar bidding war, where each company continually raises its offer price in attempts to avoid “losing” to the other. Unsurprisingly, as is typical in a scenario like this, shareholders ultimately lost in the end. Men’s Wearhouse won the takeover battle and saddled its balance sheet with $1.7 billion in debt to do it.

 

Management’s rationale for the acquisition was largely due to their belief that the way in which JOSB was marketing itself was “cancerous.” They said it ultimately led to customers having too many suits then they really wanted, and lower margins for the business. So they set out to right the former management’s wrongs. Their aim: kill the promotions. Stop tarnishing the JOSB brand name in order to pull sales forward. I don’t think I’m the only one who noticed how eerily similar this rhetoric is to Bill Ackman’s attempts to upend JC Penny’s promotional strategy. We all know how that turned out (if you don’t, JCP is highly anticipated to be entering bankruptcy courts).

 

Turning back to TLRD, it soon became painfully clear how difficult it is to change customer’s addictions to promotions. Comps for the JOSB brand that year came out to negative 16%. The following year: negative 9.5%. Management’s massive blunder was now blatantly clear to everyone involved. In 2016 the company issued a press release that let investors know how valuable the Jos. A Bank brand – the brand that management just spent $1.8 billion in shareholders money on – was now. The answer? The brand was basically worth nothing. In a press release the company told investors the following:

 

  • A write-off of the entire carrying amount of Jos. A. Bank’s goodwill, or $769 million.
  • A charge off of $335.8 million associated with the Jos. A. Bank tradename, which leaves its remaining value at just $113.2 million.
  • The entire carrying amount of the Jos. A. Bank customer relationships of $41.5 million.
  • The writedown of favorable leases connected with its acquisition of Jos. A. Bank valued at $7 million

Following that news, the Company said it also was going to be closing as many as 139 Jos. A. Bank stores, 22% of what was the total fleet. Moving forward to 2019, TLRD has closed 141 stores, and comps have been positive for the past two years at Jos. A Bank. As awful as it was, it seems the rationalization of the JOSB fleet is largely over. Things look a lot more stable.

Durability

I told you at the outset that the main concern with this stock to investors is if it will be around in 5 or 10 years or not. By no means is that a straightforward question to answer. But here’s what we know:

 

  • TLRD is a market leader and it really isn’t even close. Of course, customers have the option of going to Macy’s or JC Penny if they are in the market for a suit and in addition to that there are plenty of mom and pop-type stores in the market. These are the more regional, smaller players that every city has. But on a national basis, TLRD is the most recognized brand.
  • There is a ‘Casualization’ trend of society at large. It certainly is becoming, at least at some workplaces, accepted to wear flip flops to work. We can thank Silicon Valley for that.
  • Online Presence. Like many things in the 21st century, buying your suit attire online is becoming a possibility. Websites like iTailor and Suit Supply are probably the most recognized names.
  • TLRD has an impressive debt load.

 

Alright, with those talking points now explicitly stated, we can dig deeper into the question at hand. While I’m not typically one to doubt the profundity that the internet can have on how customers shop, it seems to me the notion that men will want to “tailor” themselves is suspect. When you’re buying a suit, that’s usually a highly personalized process. By that I mean you have to get your measurements precisely right and the sizing of suits isn’t always intuitive. That’s not something that guys who have never bought a suit before know how to do – or guys in general for that matter. Add in the fact that most guys aren’t fashion gurus, meaning we usually want a second opinion. Further, if you’re having a wedding and have to buy attire for all of the groomsmen, you certainly aren’t doing that online. Now, I certainly try to favor the empirical over anecdotal, but I don’t think my story is completely irrelevant here. For my Junior year prom, I seriously considered taking the online-DIY route. I saw a lot of ads online and it seemed simple enough. But ultimately, I ended up going to a physical location. And thankfully I did because my measurements were wildly off (but perhaps that’s just operator error). I also bought in store because the online custom suit wouldn’t have arrived in time. I feel as if that’s similar to what most guys experience. Online suit shopping sounds convenient, but it turns out not to be very practical.

 

At the end of the day I think the end market that TLRD serves is much more niche when juxtaposed with the broader brick-and mortar retail industry. While it’s true that the internet has changed how consumers interact with most retailers, I’m not sure that it has the same drastic effect in this market. If I know I’m a medium size in Tee-Shirts generally, I can confidently and easily order any Tee-Shirt I want online. But if it’s a suit? It isn’t obvious to me it’ll be as easy to get customers to go that far.

 

Okay, so conceptually, I think we a few valid reasons why the industry Tailored Brands operates in isn’t going away. What about the company itself?

 

The best way to think about a given company’s fixed cost structure was given to me by, as you can probably guess, Geoff. Instead of merely checking static ratios like debt/equity or debt/EBITDA or things of that nature, what’s more relevant is fixed cost coverage. Look at how well they are or aren’t covering fixed costs like debt repayments, interest expense, and rent. And with that information we can gage how far sales would have to decline in order for there to be liquidity concerns.

 

Let’s look at EBITDAR (Earnings before interest, tax, depreciation, amortization and rent), since TLRD is a retailer rent expense is material. For 2018, we have operating income of $211 million, depreciation of $105 million, rent of $400 million, and other non-cash charges of $24 million. So without accounting for fluctuations in working capital, we can approximate the company is generating something to the tune of $740 million before operating expenses.

 

Now what do fixed costs look like in the business? TLRD had Interest expense of $80 million in fiscal 2018 which is likely to be the same moving forward because as the company informs us in the annual report, as of February 2, 2019, 80% of the variable interest rate under the New Term Loan has been converted to a fixed rate. This means that the effect of one percentage point change in interest rates would result in an increase of $1.8 million change in annual interest expense. Current portion of the debt will be close to $10 million a year until 2022. So for the debt portion of fixed costs it appears to be not more than $100 million for TLRD. Rent for the company will continue to be $400 million. That means moving forward, fixed costs aren’t likely to exceed $500 million.

 

Using these figures, fixed costs total approximately 65% of what the company generates in cash available to be used every year for operating expenses. Put another way, sales would have to drop close to 30% in order for the company to not be able to meet its obligations, assuming a constant EBITDAR margin. Is that safe? Peak to trough through the 2008 recession sales at Men’s Wearhouse declined 9%. Sales at Jos. A Bank increased; however, I view that as misleading since JOSB was a company in a completely different phase of its corporate evolution. It was in the midst of rapid growth. Something similar to what Men’s Wearhouse experienced is probably closer to reality.

 

EBITDAR margin for Men’s Wearhouse declined from 27% to 24%, or an approximately 10% reduction. So if we assume sales at TLRD drop 20% and if assume EBITDAR margins fall to a (very conservative) 20% level, then the Company is covering its fixed costs by ~105%. So, it’s close. But the assumptions I used are quite drastic, by my estimation. It certainly doesn’t appear Chapter 11 is imminent, which is what the market would have to believe in order to price the equity in the manner which it has.

 

Management

 

“Over the last 40 years, I have built MW into a multi-billion-dollar company with amazing employees and loyal customers who value the products and service they receive at MW. Over the past several months I have expressed my concerns to the Board about the direction the company is currently heading. Instead of fostering the kind of dialogue in the Boardroom that has in part contributed to our success, the Board has inappropriately chosen to silence my concerns through termination as an executive officer” – George Zimmer, Founder of Men’s Wearhouse and former CEO (quoted following his termination).

 

 

I included the above quote because I feel what Mr. Zimmer expressed here is largely indicative of Wall Street’s sentiment towards current management. Doug Ewert, the man in charge of outing founder George Zimmer and overseeing the JOSB acquisition, was replaced as CEO in March of 2019 by Dinesh Lathi. Lathi has been with the company for over two years as a member of the board. His reputation as an executive is quite controversial. He oversaw the demise of One Kings Lane, an online home decor business which in 2014 was valued at $900 million and was subsequently sold to Bed Bath & Beyond for $12 million dollars in 2016. Given this disastrous result, Wall Street likely views Lathi as inept. However, I’m not so sure that’s entirely fair. There’s no way to run a company correctly if its business model is flawed to begin with. He only oversaw the company for 2 years, after all. It’s more likely, in my opinion, that his past failure serves to motivate him rather than being a glaring red flag of incompetence. As CEO his plan now is to hold off on the debt repayments and instead invest more in the business via expansion of the clothing line to include more casual items and invest more in the company’s omnichannel presence. By my eye, that seems to be a much more shareholder friendly strategy than overpaying for acquisitions or retiring low yielding debt.

 

Pick Your Metric – It’s Cheap

 

In the beginning of this article I laid out a few back of the envelope valuation metrics. To give you a more tangible idea, most retailers trade around an EV/EBITDA multiple of 8. But TLRD might be shrinking. Or maybe investors will never get comfortable with the CEO. So one might argue that TLRD will never reach “normal” trading multiples. Okay, let’s assume a fair value for TLRD is an EV/EBITDA multiple of 6.

 

On an enterprise basis that brings us to ~$1,900 million. When we take out the $1.1 billion in debt, we’re left with an equity value of $800 million. With 50 million shares outstanding, that’s a fair value of $15/share. The dividend yield that you get is somewhat meaningless when the equity should be worth (at least) double what it current is trading for. But dividends have been $0.72/share for many years. Truth be told I would much prefer management cuts the dividend program and just buys back stock.

 

A somewhat more speculative opinion would be that this just isn’t the time to own anything consumer discretion related. That certainly is what the market thinks. Playing devil’s advocate, what’s most concerning to me about this situation is that you could have made similar arguments 1 or 2 years ago about similar retailers. Back in 2017 an extremely less experienced version of myself took a close look at Bed Bath and Beyond. Similar to TLRD, I was attracted to BBBY’s impressive cash flow generation and seemingly strong market niche. The stock’s been more than cut in half since it piqued my interest (I, luckily, have not been along for the ride).

 

Maybe this is just the market merely being irrational. There’s no law of investing that states a cheap stock must go up, as you all know. Certainly not in the short term. Perhaps though, the market is merely pricing in a cyclical top. Comparable sales at TLRD have been trended positively the past few years. However on the last conference call, Management said that Q4 comparable sales were negative and they expected Q1 2019 to be negative as well. At current valuation levels, a chance of recession is clearly being discounted in the stock price. However, sales would have to more than fall off a cliff and the company would have to enter bankruptcy courts in order for the current market price to make any sense. I’ve laid out the case why I think to reach the conclusion that TLRD is going out of business requires faulty assumptions.

 

Conclusion

 

Ultimately, I don’t think this is a stock for the concentrated investor. If you buy a basket of, say, 5 of these types of situations then that portfolio should perform very well over a period of 3-5 years. Any time you have an extremely levered balance sheet coupled with a business that could very well be in secular decline, you can’t establish a concentrated position in the company. Or at least you probably shouldn’t. You should buy a basket of similar situations.

 

But the retail sector has been hit enormously hard over the past few years, and maybe you think that it is overblown, and you wish to exploit it. In that case, instead of making TLRD a 10%-15% position, it’d be best to pick 3-5 similar companies and make that basket a 10% or 15% position. And to those of you who aren’t as concentrated as Geoff yet still don’t wish to own a basket of troubled retailers, I think taking a smaller speculation position in this stock makes a lot of sense. It could triple in the next year and it wouldn’t really surprise me.

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