Description

NYSE:TLRD (f.k.a. MW)

Men’s Wearhouse 7% Senior Notes due 2022 (the “Senior Notes”) trade at 69 to yield 15%, with a current yield of 10% and >50% upside over the next twelve months.

With high yield spreads in non-energy/industrials/mats sectors widening for the first time in years, some opportunities are arising in credits that are well covered by their collateral, performing, and have little chance of impairment.  Men’s Wearhouse 7% Senior Notes due 2022 (the “Senior Notes”) stand out for their (i) rich 15% yield, (ii) EV coverage, (iii) free cash flow, (iv) deleveraging potential, and (v) the resiliency of the TLRD business even if the economy slows.  They are unique in that the core business of Men’s Wearhouse’ legacy banners is stable, growing, and highly FCF generative.  The only reason that the Senior Notes are trading at stressed levels is due to the flawed acquisition of Men’s Wearhouse’ closest competitor, Jos A Banks.  However, bifurcating JOSB from the legacy banners, it is clear that the Senior Notes are well covered by the EV of the legacy banners alone, and FCF is sufficient not only to service the Senior Notes but also to deleverage the capital structure through paydown of term loan debt (the “TL) and repurchases of Senior Notes in the open market. 

While the path to rationalizing the JOSB business may be non-linear, I believe the Senior Notes are well covered by the value of the legacy business alone (attributing no value to JOSB), and the risk of permanent impairment to the Senior Notes is very low.  I see upside to par+ for the Senior Notes as mgmt (i) closes unprofitable JOSB stores to rationalize the business segment, (ii) pursues initiatives to stabilize the SSS of JOSB, (iii) potentially cuts the equity dividend, and (iv) deleverages the balance sheet through pay-down of the TL and open-market purchases of the Senior Notes with FCF and cash-on-hand.  There is also the possibility that Men’s Wearhouse could be acquired by a private equity sponsor (plausible given the stock’s depressed trading level), and such a change-of-control would trigger a put option for the Senior Notes at 101, resulting in a par+ recovery (>50% upside).  In the absence of one of these upside scenarios, the Senior Notes will still yield 15% to maturity with a ~10% current yield, while creating the enterprise at just ~4.5x my conservative (well below Street) EBITDA. 

SITUATION OVERVIEW

In the spring of 2013, Men’s Wearhouse's (“TLRD” or the “Company”; formerly “MW”) 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 $150mm 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 back then, 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/sh 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 mgmt 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/sh in cash.  The deal closed in June 2014, and was financed with $1.7bn of debt, encumbering TLRD’s previously unlevered balance sheet. 

With the acquisition complete, TLRD became a popular HF stock.  Mgmt’s synergy projections and overly optimistic long-term EPS targets propelled the stock to over $60/sh briefly in June 2015.  However, it subsequently sold off to $40/sh 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 forecasted 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 mgmt reported that JOSB’s SSS continued to accelerate to the downside, now looking to be down ~35% in the 4Q.  The stock now trades at below $14/sh, down over -75% since it peaked in June.

The downward re-rating of TLRD’s stock in November 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 (currently at ~69). 

The situation remains dynamic as we wait for JOSB’s revenue to stabilize and learn how mgmt will approach capital allocation.  It is possible that JOSB EBITDA could go to zero or negative in 2016 if the current business trajectory continues.  I have underwritten the Notes based on the assumption that JOSB will be a detractor from cash flow over at least the near-term, but that mgmt will stabilize or rationalize the business over time.  AlixPartners (a well-regarded operational and financial restructuring shop) has been advising the Company on the integration of JOSB, and is now exploring rationalization opportunities for unprofitable stores.  While the majority of leases are not immediately terminable, I do believe that there is a substantial opportunity to exit expiring leases and negotiate with landlords to walk away from certain other locations.  In time, JOSB should be able to cut a meaningful amount of its $150mm of occupancy costs and get back to EBITDA break-even/positive.     

With regard to capital allocation, mgmt recently froze its optional paydown of TL debt while it was evaluating alternatives (e.g., buying its way out of JOSB leases).  The Company remains cash flow generative and may choose to cut its equity dividend, which would free up a further $35mm per year for debt reduction.  Mgmt has also communicated its (unlimited) ability to repurchase Senior Notes in the open market, an approach I have confirmed is viable based on credit documents.  Public market purchases of bonds would significantly benefit the Senior Notes both technically and through outsized deleveraging of the capital structure.  With the bonds trading below 70, each $1,000 of cash can repurchase over $1,400 face value of bonds.

Just yesterday (on 2/16), TLRD preannounced an inline to slightly positive 4Q’15, indicating that the core legacy banners continue to perform well.  SSS were +4.3% in the flagship banner, and JOSB SSS improved throughout the quarter to come in better than Mgmt’s guide from December (albeit still down ~32%).  Mgmt intends to provide an update on its real estate and capital allocation strategy in March when they report 4Q earnings.  While there is uncertainty as to the topline and margin trends of the JOSB business near-term, the legacy businesses continue to trend positively; and the announcement of store rationalization and the resumption of debt paydown in March could be the next catalyst for a move higher in the bonds. 

BUSINESS OVERVIEW

TLRD operates the largest national chain of tailored clothing retail stores, including 709 Men’s Wearhouse banner stores (together with the Tux Shops, ~50% of sales ), 183 tuxedo shops (the “Tux Shops”), and 211 Moore’s and K&G locations (together, ~15% of sales).  In 2014, the Company acquired 629 JOSB stores (~25% of sales), and it also operates a corporate segment serving businesses in the US and UK (~10% of sales).  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 tuxedo business is a remarkably stable, high margin business that grew even through the 2008-09 recession. 

TLRD’s 183 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, mgmt 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 sqft and sales/sqft, even as the number of total Men’s Wearhouse and Tux Shop stores have 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 casualwear, 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.  Until fairly recently, 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 ~$1bn in revenue.  I believe TLRD may have gone too far in its sweeping changes at JOSB, as the topline came under pressure immediately after the acquisition closed.  However, it wasn’t until 3Q’15 when mgmt terminated JOSB’s buy-one-get-3 (“BOGO3”) promotion that sales turned down significantly. 

TLRD has been communicating for some time that they 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 mgmt 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 suit, TLRD mgmt hoped they could grow clothing margins and gross profit even as the topline may decline somewhat.  While clothing margins have improved, the unexpected and extreme fall-off in JOSB’s sales have resulted in meaningfully lower gross profit and EBITDA.  Essentially, the deleverage of falling sales against occupancy costs (included in COGS) are being only partially offset by higher clothing margins and improving tuxedo margins (the result of TLRD bringing JOSB’s tuxedo rental business in-house). 

Mgmt is working to calibrate the appropriate marketing and promotional strategy to replace BOGO3, but admits the next few quarters of difficult y/o/y compares will be a significant challenge for the business.  They have indicated “there's not much that's off the table” in terms of approaches they are evaluating to stabilize the JOSB business.  While mgmt has not explicitly signaled any willingness to return to BOGO3 promotions, it is possible that they may roll back some of the other changes they have implemented at JOSB since the acquisition, which could help in stabilizing sales.     

MODEL

The summary output from my model below breaks out the legacy banners separately from JOSB.  Mgmt has broken out gross profit for JOSB since it was acquired.  On a consolidated basis, I model SG&A as growing 1-2% annually after synergies.  Mgmt does not break out JOSB’s SG&A, so I have taken the approach of modeling the legacy business’ SG&A (adjusted for non-recurring items) and assuming that any excess G&A is attributable to JOSB.  So, any SG&A reinvestment in the JOSB business or synergies realized therefrom will all be netted into the JOSB SG&A line item. 

My 2016 EBITDA is well below (equity) sell-side numbers due to the drag from JOSB, but the consolidated business still generates meaningful FCF even in my conservative scenario.  As we move forward into FY’17-18, mgmt should have stabilized the JOSB business and meaningfully rationalized underperforming stores – thereby mitigating JOSB’s drag on EBITDA and FCF.  In time, mgmt should get JOSB back to profitability (albeit on a smaller store base), which will make the segment credit enhancing, rather than a drag on the trading value of the bonds.

THE CREDIT

The 2014 acquisition of JOSB levered TLRD’s previously clean balance sheet with $1.1bn of fixed and floating-rate first lien term loan (the “TL”), a $500mm undrawn revolver, and $600mm of the Senior Notes.  Indicative of the robust credit markets and investor fervor for the JOSB deal when it was financed, the debt has no maintenance covenants and long-dated maturities.  The TL is the first maturity of funded debt, and it isn’t until 2021.  With over $50mm of cash and an undrawn revolver, TLRD has plenty of liquidity, and the business remains significantly cash flow positive.  So, the risk of default under the bank debt or bonds is extremely low.

It’s helpful to look back to how TLRD’s legacy businesses performed in the depths of the 2008-09 recession.  This is clearly an overly conservative economic scenario to extrapolate to today, but even during those dire years of 10% unemployment and carnage across the retail sector, TLRD maintained positive FCF.  Against the backdrop of a 13% cumulative drawdown in SSS, TLRD’s EBITDA troughed at $185mm.  Since then, mgmt acquired a $200mm (in sales) Corporate segment business, and I believe that were this draconian 2008-09 scenario to repeat itself, the legacy TLRD business would generate greater than $200mm+ of EBITDA and remain FCF positive.              

The Senior Notes create the Company at just 4.5x my ‘Conservative’ (well below Street) 2016 Adjusted EBITDA, which may well turn out to be too pessimistic.  Even assuming ‘trough’ EBITDA of $200mm, the Senior Notes still create the Company at just 7.2x EBITDA.  So I view the Senior Notes as unimpaired in almost any plausible scenario. 

Behind the debt, TLRD’s public market capitalization currently stands at just over $650mm.  While this equity “cushion” is volatile and susceptible to further deterioration if investors’ expectations for earnings are set too high, it is yet another indication of the adequate EV coverage afforded the Senior Notes.  The fall in the stock price also introduces an interesting upside case for the bonds, if an equity sponsor were to take advantage of the depressed public equity value to take TLRD private.  This is purely speculation, but we could see George Zimmer (the “you’re going to like the way you look” guy) partner with PE and take a run at TLRD; George was forced out by the BOD in 2013 after a power struggle.  The Senior Notes have a change-of-control put option that would be triggered in any take-private scenario, allowing holders of the Senior Notes to put their notes back to the Company at a price of 101, over 50% upside from current trading levels (including the coupon). 

CONCLUSION

In the current market, where investors are underwriting the possibility of a recession and return to trough valuation levels, TLRD’s Senior Notes offer a uniquely attractive combination of downside protection and significant upside.  Holders of the Senior Notes earn a 15% yield while we wait for the catalyst that will take these notes back to par+ for a >50% total return.  Even in a dire downside case for the economy, the Notes are covered by the value of TLRD’s legacy business, with JOSB providing further valuation upside optionality.  Finally, I believe mgmt will imminently begin buying back the Senior Notes in the open market and may choose to cut the equity dividend, as they direct their FCF to deleveraging the balance sheet. 

Catalyst

Senior Notes repurchases by TLRD in the open market
Mgmt cuts the equity dividend
Deleveraging through FCF
Rationalization of JOSB's real estate
Stabilization of JOSB's topline