The low end of my
valuation range translates to a p/e of 14.6x my 2008 estimate of ~$3.09 eps per
share, or about 15% growth over the ~$2.70 eps they are on track to earn in
2007. The low-end valuation also represents 6.4 2008 ev/ebitda. When business
trends are strong the stock will trade at an 18 to 20 p/e and at 8+ ev/ebitda;
these multiples are required to achieve my high end valuation. The stock traded
at the high-end valuation level as recently as June of this year.
I first wrote up JOSB
in July 2006 at a price of $26. This followed an earnings miss and sell off
that occurred in Q1’06. Since that time the stock traded as high as $45 back in
June. The rise in the stock price came as the market realized that the miss was
a one-off problem, as earnings grew 20% yoy including accounting for the Q1
earnings miss, and as net cash began to accumulate on the balance sheet.
Since June the stock
has sold off from its high (to $35) as has most of retail. I have lowered my
expectations for growth for the remainder of this year and through ’09 to 12%
top-line growth and 15% bottom-line growth. However, at any point in time in
which consumer spending picks up I am confident that the earnings leverage
inherent in their model will kick-in and it is likely that the company will
produce earnings growth of 20% (or in excess of that) as they have consistently
from ’02 to ’06. At that time the trading multiple will expand back toward old
highs and it will be on higher earnings than I now model, thus adding further
upside.
The big picture is
what I believe is most important about the Bank story. With that in mind I
recommend members go back and read my report from 2006. Though the report
spells out what happened when the company missed earnings in Q1’06, it also focuses
in detail on what I believe are the critical aspects of the story; namely, an
effective but misunderstood business model with high returns on capital, strong
cash flow generation (see free cash flow & fcf yield in valuation section),
and a hidden earnings leverage story. The only material change from my earlier
report is that I have lowered the growth rate to reflect the current consumer
spending environment. This should normalize higher again when the economy
improves.
Bank’s business model
generates strong debate and this deserves an update.
Bank’s business model
is designed to take advantage of the way men shop through a high in-stock
inventory position. Put another way, Bank has high inventories. Their theory is
that men buy their clothes once or twice a year, generally all buy the same
thing, and when they show up at a store if the store is out of what they want
they simple go on to the next store. If a store does not have enough of the
sizes and enough of each size of the standard white or blue dress shirt (or
whatever) when the customer shows up, then the sale is lost forever. The theory
continues, that if one carries a lot of inventory, especially of men’s basics
that make up two-thirds of inventory, it should generate more sales. I believe
the strategy is effective and in my initial report I detail how this comes
through in company metrics such as sales per sq ft, margins, returns, etc.)
At the time of my
earlier write up Bank had nearly a year’s worth of inventory and had just come
off a bad quarter. Inventory up near a year (or 1 turn) is not abnormal for
Bank, but nonetheless was a new high. Management claimed inventory was not a
problem (of course) and argued that margins would rebound from their poor Q1’06
performance and all this has come true. However, back then they also noted that
they intended to improve cash flow (which was strong to begin with) via a
slower inventory build going forward, a tacit admission that inventories were
at least a bit too high. Indeed, inventory days has declined from 352 days when
I wrote my report to 314 at the end of the most recent quarter. Over the past
year sales have grown 12.7% while inventories have declined 4.7%.
After following this
company closely since 2004 and finally buying shares in 2006, I am convinced
that Bank is no more likely to have problems with inventories than any other
retailer. What retailer does not have issues with holding too much inventory in
general or too much of the wrong inventory from time-to-time? At the specialty
retailer level I know of none. I believe that Bank’s strategy of high inventory
has proved itself overtime, even if from time-to-time they will make mistakes
on implementation.
Management continues
to be as cantankerous as ever. Similar to Mens Wearhouse they now no longer are
providing monthly same store sales and similar to Bed Bath & Beyond they
are no longer offering Q&A on quarterly eps calls. The difference between
MW and BBBY and JOSB is that even though JOSB is now doing what some others in
the space are doing, they manage to do so in a manner that alienates
shareholders. Management has been effective at creating value, but nonetheless
I wish they would change their manner of dealing with the Street.
During the Q2
conference call management outlined plans to expand to 600 stores, 100 higher
than the previous plan of 500 stores. The store count is currently at 391.
Further goals are to have $1.0B in sales by 2001 and $90M in net profits. This
equates to approximately $5.00 eps on current share count. I believe a strong
economy would yield higher numbers than that on the same number of stores.
Moreover, by then they would have either significant cash on the balance sheet
or a lower share count (as long as they do not make a dumb acquisition; none
are planned).
My current estimates
are as follows:
Store count 376 426 476 526
Revenue ($M) 546 616 691 775
Net income 43.2 49.5 57.1 65.5
EPS ($) 2.36 2.69 3.09 3.55
Shares 18.3 18.4 18.4 18.4
GROWTH (%)
Revenue 17.6% 12.8% 12.1% 12.1%
EPS 20.5% 14.0% 15.1% 14.8%
(Net income includes interest on growing cash
balances and tax rate at 41.6%, which may turn out to be a little high.)
Op Inc 73.1 83.3 94.8 107.8
EBITDA 88.9 101.9 115.1 129.7
FCF TO EQUITY
2006 2007
2008
2009
Net income 43.2 49.5 57.1 65.5
Depreciation
15.8 18.5 20.2 21.9
Capex, Maint (3.8) (4.1) (4.8) (5.6)
FCF to Equity
After maintenance
capex only
55.2 63.9
72.5
81.8
Capex, growth (27.3) (25.4) (26.3) (27.3)
WC delta
4.5 (10.2) (15.0) (15.0)
FCF to equity
after growth
expenditures
32.4 28.3
31.2
39.5
WC delta for ’06 is
as reported.
WC delta for ’07 is
reported WC delta for first six months of ’07 less inventory build for
remaining ’07 new stores.
WC delta for 2008 and
2009 represents only inventory build for new stores.
Assumes $300K
inventory build for new stores
I have valued the stock on p/e and ev/ebitda.
However, stripping out growth capex and inventory build reveals the real cash
flow potential that will be realized when growth stops. However, even when new
store growth stops, stores take up to 5 years to mature and should go from a
mid-teens four-wall op margin to a mid to high twenties margin. Thus eps growth
should remain strong for a few years. This is all detailed in my original
report.
Recent Price: $35.00
Cash as of 7/31/07: $43M
No debt
2007 2008 2009
Market Cap 645 645 645
Cash 58 89 129
EV 587 556 516
EV/EBITDA 5.8 4.8 4.0
P/E
13.0 11.3 9.9
FCF yield to EV
before growth expense 10.8% 13.0% 15.9%
FCF yield to EV
after all growth exp 4.8%
5.6% 7.7%
growth expense = growth capex + WC delta (wc
delta = new store inventory build)
RISKS
Fashion misses. A further slowdown in consumer
spending.
Continued expansion of new stores, margin expansion as stores mature and growth continuing at current levels or better.