Joseph A Bank JOSB
October 08, 2007 - 7:32am EST by
beep899
2007 2008
Price: 34.85 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 645 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Joseph A Bank (JOSB) is a men’s business apparel specialty retailer which is taking share in the menswear space, rapidly expanding its store count and is on track to grow earnings at a rate of 15% to 20%+ per year for the next three to four years based on a combination of new store expansion and margin improvement as exiting stores mature. Over the next 12 to 18 months I believe the stock is worth $45 to $55 depending on business trends. My valuation equates to an increase of 29% to 57% from the current stock price of $35.

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:
 
 
INC STMT          2006        2007       2008        2009       
 
Store count       376         426         476         526
 
Revenue ($M)      546         616         691         775  
 
Op Inc            73.1        83.3        94.8        107.8
 
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.)
 
 
EBITDA            2006       2007       2008        2009 
 
Op Inc            73.1       83.3        94.8       107.8
Depreciation      15.8       18.5        20.2       21.9
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
 
 
 
 
VALUATION                    
 
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.
 

 


Catalyst

Continued expansion of new stores, margin expansion as stores mature and growth continuing at current levels or better.
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