garrett merrell casey smith colby mcclellan emily...
TRANSCRIPT
Garrett Merrell
Casey Smith
Colby McClellan
Emily Yelverton
2
Table of Contents
Executive Summary 4
Firm Overview 10
Industry Overview 13
Five Forces Model 14
Rivalry Among Existing Firms 15
Threat of New Entrants 21
Threat of Substitute Products 24
Bargaining Power of Customers 24
Bargaining Power of Suppliers 27
Value Chain Analysis 29
Cost Leadership 30
Differentiation 32
Competitive Advantage 34
Accounting Analysis 38
Accounting Policies 39
Potential Accounting Flexibility 41
Actual Accounting Strategy 43
Quality of Disclosure 45
Quantitative Analysis 48
Potential Red Flags 56
Undoing Distortions 57
Financial Analysis 59
Liquidity Analysis 60
Profitability Analysis 69
Capital Structure Analysis 75
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SGR & IGR 79
Forecast Financials 80
Income Statements 81
Balance Sheets 83
Statement of Cash Flows 86
Cost of Capital Estimation 90
Valuation Analysis 93
Method of Comparables 94
Intrinsic Valuation 99
Discount Dividend 99
Free Cash Flow 100
Residual Income 102
Abnormal Earnings Growth Model 103
Credit Analysis 105
Recommendation 106
Appendix 107
References 132
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Executive Summary
MW - NYSE(11/1/2007): $42 52 Week Range: $32.00-$56.64 Revenue: $2.13 B Market Capitalization: $1.71 B Shares Outstanding: 53.1 M 3-month avg. Daily Trading Volume: 938,898 Percent Institutional Ownership: 98.80% Book Value Per Share: $15.385 ROE: 26.12% ROA: 14.96%Cost of Capital est. R2 Beta Ke
Estimated: 3-month .0085 -.71 -1.66% 1-year .0083 -.706 -1.63% 3-year .0084 -.708 -1.65% 5-year .0088 -.714 -1.70% 10-year .0093 -.721 -1.76% Published Beta: 1.55 Kd(AT): 7% WACC(BT): 13.87% WACC(AT): 13.10%
Altman's Z-score 2002 2003 2004 2005 2006 3.52 3.18 3.32 3.5 4.32 Valuation Estimates Actual Price (11/1/2007): $40.47 Financial Based Valuations Trailing P/E: 9.47 Forward P/E: 9.73 P.E.G.: .68 P/B: 2.19 P/EBITDA: .11872 P/FCF: N/A EV/EBITDA: 6.359 Intrinsic Valuations Discount Dividend: $4.12 Free Cash Flows: $39.71 Residual Income: $7.73 AEG: $6.06
http://moneycentral.msn.com http://moneycentral.msn.com
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Industry Analysis
In 1973, George Zimmer and his college roommates founded Men’s Wearhouse,
and shortly after they opened their first store in 1974. Based out of Houston, Texas,
Men’s Wearhouse operates over 636 stores throughout the United States and 116
stores in Canada. The Men’s Wearhouse’s target market includes men whose needs
vary from casual everyday business clothing to tuxedos for those special occasions.
They offer a wide selection of apparel as well as belts, shoes, jewelry, cologne, and
gloves. Over the past five years, the Men’s Wearhouse’s assets, stock price, and total
number of stores in operation has steadily increased.
Men’s Wearhouse competes with a few very strong companies in the specialty
men’s apparel industry. These direct competitors include Jos. A. Bank, Brooks Brothers,
and department stores including Dillard’s, Macy’s, and Nordstrom’s. The industry that
these firms compete in is one of the largest in America. The U.S. retail industry
generates $3.8 trillion in sales annually, approximately $11,991 per capita
(retailindustry.about.com). Firms already within the men’s specialty retail industry
compete for market share on tight cost controls, cost leadership, and brand image. The
product lines offered in this apparel industry allow for a high threat of substitute
products and low switching costs for customers is
It is very important for firms to differentiate themselves from their competitors in
this industry. A major component of doing this is to maintain a high percentage of
market shares. Another way companies differentiate their firm from their competitors
in this specialty industry is by attempting to sell their products to their customers by
offering the lowest price. Companies can also differentiate by offering extra services to
customers such as tailoring, maintaining quality customer relations and offering new
and innovative ways to make their product more available such as catalog or online
stores.
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The key to success in this specialty men’s retail industry is to gain competitive
advantage over competitors. The key success factors within this industry include
investment in brand image, maintaining low input costs, offering excellent customer
service, and keeping prices low. Firms can steal market share and become the leader
by developing these success factors.
Accounting Analysis
All accounting information follows the same basic guidelines but can come
in different levels of aggression. Some statements offer minimum information to satisfy
required General Accepted Accounting Principles and some offer more for the user.
When these statements disclose more aggressively, the user has much more
information to analyze. The discretion is up to the firm. Using their own style of
discretion and unique key accounting policies, firms can influence their statement’s
results to make their company appear the way they desire. Managers are usually given
more flexibility through GAAP when disclosing key accounting policies than when
disclosing their firm’s key success factors.
Men’s Wearhouse’s key success factors are economies of scale and tight cost
control. These success factors distinguish a company’s competitive advantage. It is
feasible for Men’s Wearhouse to achieve economies of scale as a result of the high
competition in the men’s retail industry. Price competition has forced them to expand
their scale of operations. Men’s Wearhouse practices tight cost control through the
utilization of low-cost distribution and low input costs.
Once a company’s keys success factors are recognized, analysts can identify key
accounting policies that are influenced by these factors. The key accounting policies
found for Men’s Wearhouse are pension liability programs, including health benefit costs
and workers’ compensation, and operating versus capital leases. All firms must account
for their own benefit plan pension liabilities and this is often area that is distorted in
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order to make costs appear better. In terms of capital versus operating leases, Men’s
Wearhouse has chosen to apply operating leases on a straight line basis. Men’s
Wearhouse has chosen the aggressive approach in disclosing information that will affect
their reported earnings by making them higher. This is made apparent when analyzing
how they capitalize their operating leases. They account for these leases as an expense
rather than liabilities, allowing for higher reported earnings. Despite their
aggressiveness, they are still clear and effective when supplying information to
suppliers.
There was little need to raise red flags when analyzing Men’s Wearhouse’s
disclosure. There was no indication to raise a red flag when examining assets because
there were not any sizable asset write-offs. However, when studying the Men’s
Wearhouse sales to inventory ratio, a red flag was raised. This is so because there was
an unusual increase in inventories in relation to sales increase. When examining the
asset turnover ratio, we determined little fluctuations because all assets were included.
Therefore, no red flags were raised.
Financial Analysis, Forecast Financials, and Cost of Capital Estimation
Analysts use a series of ratios in an effort to measure the financial performance
of a company in comparison to their main competitors in the industry. The most
beneficial financial analysis that they perform include the valuation of liquidity ratios,
profitability ratios, and capital structure ratios. Furthermore, we are able to forecast
future financials with the use of these ratios. This helps to distinguish changes in the
firm over time. Lastly, Men’s Wearhouse’s Beta is distinguished and used to calculate
the cost of debt, the cost of equity, and the before and after weighted average cost of
capital.
Through the valuation of Men’s Wearhouse’s liquidity ratios, we have found this
company to be a liquid firm. They outperform their sole competitor of their industry,
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Jos. A. Bank. The majority of Men’s Wearhouse’s liquidity ratios prove to have
favorable impacts. This proves that in the event of short-term debt obligations, Men’s
Wearhouse would be able to provide the necessary liquidation. From analyzing their
profitability, we have found that Men’s Wearhouse is very proficient in turning a profit.
Operating efficiency, asset productivity, profitability from assets, and profitability on
investments are all achieved and are improving with time. They are also in line with the
industry standard. Finally, we have found that Men’s Wearhouse has a solid capital
structure. They have a lower credit risk than their competitor, Jos. A. Bank, due to
their lower debt to equity ratio. Although their times interest earned ratio is lower than
that of their competitor, Men’s Wearhouse appears to be more stable because their
ratio has been more constant over the past five years.
Several methods and techniques were used to forecast the future financials of
Men’s Wearhouse. After analyzing their financial statements and calculating their
financial ratios, we were able to use the information we found to forecast the Income
Statement, Balance Sheet, and Statement of Cash Flows. Through analyzing the
trends of the income statement, we believe that the Men’s Wearhouse sales will
continue to grow at 9.5% per year. The asset turnover was used to link the balance
sheet to the income statement. Sales derived from the income statement were used to
forecast assets on the balance sheet. Cash flows from operations were analyzed by
comparing the CFFO/Sales and CFFO/Gross Profit. Through this analysis, we found that
CFFO will increase annually at a 9% rate of sales or 20% rate of gross profit.
Valuations
Once we completed an analysis of Men’s Wearhouse’s industry, accounting
policies, and financials, it is much easier to perform a valuation of this firm. We used
two key sets of methods to valuate Men’s Wearhouse. These include the method of
comparables and intrinsic valuation models. The method of comparables is a valuation
model that factors in up-to-date financial statistics from the Men’s Wearhouse and their
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competitors to arrive at an industry average. This method is not completely reliable,
therefore, we have incorporated a more theoretical method of valuation to obtain a
more accurate estimate of the value of the company. In performing the intrinsic
valuation model, we used previously calculated ratios and estimates to obtain intrinsic
values for each of the individual models we used. After we identified if the observed
stock price of the Men’s Wearhouse aligns with our predicted intrinsic values, we were
able to recognize whether their stock is fairly valued, undervalued, or overvalued.
The Method of Comparables has given us all three of the different results for
valuation; undervalued, fairly valued, and over valued. The majority of the ratios
however have demonstrated that Mens Wearhouse is slightly overvalued. This method
is not the strongest and most reliable for a company because they will not all perform
at the industry average. Every company in every industry has its own unique success
factors, accounting policies, and structure; meaning it is impossible to assume they will
all perform alike.
The four models we used to determine the intrinsic valuations were the Dividend
Discount Model, the Discounted Free Cash Flows Model, the Residual Income Model,
and the Abnormal Earnings Growth Model. The Discounted Dividends Model is not a
reliable model to value a firm, especially for the Men’s Wearhouse because they have
only paid dividends for one year. Next, the Discounted Free Cash Flows Model is the
only model that shows our firm to be fairly valued. This is the only model that uses
WACC in the sensitivity analysis. The third and most accurate model we used was the
Residual Income Model. This model also overvalued the Men’s Wearhouse with a cost of
equity of 17% and a growth rate of 9%. Finally, the AEG Model at a 17% cost of
equity and an 8% growth rate also overvalued the Men’s Wearhouse. If the firm was
able to lower their cost of equity to 9% and growth to 6% would the Men’s Wearhouse
would be fairly valued at $40.47. However this is highly unlikely because the cost of
debt is 7% and the cost of equity is always higher. From this thorough analysis, we
have found Men’s Wearhouse to be over valued.
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Firm Overview
Based out of Houston Texas, Men’s Wearhouse operates over 543 stores
throughout the United States and 116 stores in Canada. George Zimmer and his
college roommates founded Men’s Wearhouse in 1973, where shortly after they opened
their first store in 1974. Since then, Men’s Wearhouse boasts one of America’s largest
specialty retail stores designed to cater to a variety of men’s clothing needs. George
Zimmer has become a household name associated with the popular phrase “I guarantee
it”. Men’s Wearhouse became a publicly traded company in 1992 which raised 13
million in the initial public offering. George Zimmer’s men’s clothing store now averages
approximately one additional store a week in the United States
(www.menswearhouse.com). The Men’s Wearhouse target market includes men whose
needs vary from casual everyday business clothing to tuxedos for those special
occasions. Their inventory consists of designer names including K & G Fashions,
Moores Clothing for Men, Men’s Wearhouse Designs, and many other nationally
recognized brand names. They offer a wide selection of products including suits, sports
coats, dress shirts, ties, sportswear, outerwear, gift cards, tuxedos, and shoes. Their
accessory department enhances these products by offering wallets, belts, jewelry,
gloves, and cologne.
The following chart displays Men’s Wearhouse total assets and stock price
valuation over the past five years. Over the past five years, the Men’s Wearhouse’s
assets, stock price, and total number of stores in operation has steadily increased since
2002.
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Assets and Stock Price Valuation
2002 2003 2004 2005 2006 2007
(Current)
Total #
Stores
680 689 693 707 719 752
Assets
($)
728,976 780,104 878,127 993,322 1,123,274 1,096,952
Stock Price
($)
11.34 16.54 21.14 29.21 38.17 48.58
The stock price has amplified by several points each year over the past five years. Stock price has increased 3.28 percent since December 2002. This allows the current price of 48.58 to be 37.24 points above the price five years ago.
Net Sales and Sales Growth
2002 2003 2004 2005 2006
Net Sales
($)
1,295,049 1,392,680 1,546,679 1,724,898 1,882,064
Sales Growth
(%)
1.69 7.01 9.95 10.33 8.35
The above chart exhibits the sales growth and net sales growth the Men’s Wearhouse has experienced from 2002-2006. Note that the time period from 2005-2006 displays the only time period in which the Men’s Wearhouse has had a decrease in the rate of sales growth as a percentage.
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Direct competitors of the Men’s Wearhouse include JoS. A. Bank, Brooks
Brothers, and department stores including Dillard’s, Macy’s, and J.C. Penney. All of
these companies target middle to high end customers. Firms already within the men’s
specialty retail industry compete for market share on tight cost controls, cost
leadership, and brand image. The product lines offered in this industry are relatively
similar allowing for a high threat of substitute products and low switching costs for
customers. Most of the companies in this industry competing on low prices will attempt
to enhance the product offering quality. The Men’s Wearhouse prides themselves on
unsurpassed customer services and a quality product at everyday low prices
Another major vital component in the men’s specialty retail industry is to
maintain a high percentage of market shares through differentiation amongst
competitors. This industry competes on specialty clothing items and companies within
the industry, such as Men’s Wearhouse, differentiate themselves by offering accessory
items and custom tailoring to fit individual consumer needs. Offering these extra
services in turn affects the input costs in selling men’s specialty clothing which affects
the price of the products being sold to customers within the market share. At the same
time, these companies attempt to sell their products to their customers by offering the
lowest price.
The key to success in this industry is to gain a competitive advantage over
competitors. The key success factors within the men’s specialty retail industry include
investing in brand image, maintaining low input costs, offering excellent customer
service, and keeping prices low. By developing and enhancing these key factors,
companies will steal market share and be the leaders of the industry.
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Industry Overview
The retail industry is one of the largest industries in America. Over all, the
industry employs the second most people in America and has the second most
establishments (retailindustry.about.com). The U.S. retail industry generates $3.8
trillion in sales annually, approximately $11,991 per capita (retailindustry.about.com).
The Men’s Wearhouse is specifically a men’s apparel retailer and is one of North
America’s largest specialty retailers (menswearhous.com). There are several
competitors in this industry, but you can separate them into three main categories;
large men specific retailers, privately owned retailers, and department stores that offer
men’s apparel. Jos. A Banks is a large men’s specific retailer in the industry. They were
established in 1905 and have over 350 stores nationwide (josabank.com). Their
company philosophy is based on eliminating the middle man between Jos. A Bank and
the clothing factories, to keep their prices low. JoS. A Bank claims that their prices are
20-30 percent lower than their competitors (Josabank.com). Next, one of the largest
privately held companies in the men’s apparel industry is Brooks Brothers. Founded in
1818, it was the first ready-to-wear fashion emporium in America
(brooksbrothers.com). They started as a men’s apparel store, but have added a
women’s line as well. However, Brooks Brothers is known for their gentleman’s “old
school” classic look as their style of apparel and target market has not changed much
over the last two centuries. They appeal to the higher-end consumer with high-quality
products and the prestige of the Brooks Brother name. In fact, President Abraham
Lincoln was wearing a Brooks Brother suit and overcoat when he was assassinated in
1865. Next, department stores such as Dillard’s, Macy’s, J.C. Penney, and Nordstrom’s
take a large part of the industry. Their ability to provide a wide variety of items and
brands on the same shelves helps draw customers.
The retail industry is very competitive and in order for a company to survive they
must have a significant competitive advantage in the market. This is great for
consumers because companies are forced to fight tooth and nail to create a quality
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product at the lowest price possible. Many times this causes companies to specialize
making a specific product for a specific market. It is generally much more affective to
do one thing and do it well. Therefore, in the U.S. many apparel retailers have tailored
their product lines solely to men.
Five Forces Model
The Five Forces Model is a guideline which analysts may use to evaluate a
particular industry’s structure and profit potential. The Five Forces Model includes two
sub-categories: the degree of actual and potential competition, and the bargaining
power of input and output markets. The degree of actual and potential competition is
further organized by rivalry among existing firms, the threat of new entrants, and the
threat of substitute products. The bargaining power in input and output markets
include the bargaining power of buyers and the bargaining power of suppliers relative
to a specific industry. Essentially, the Five Forces Model allows analysts to logically
assess prospective problems in an industry that may affect the overall profitability of
the firms.
Rivalry Among Existing Firms Moderate-High
Threat of New Entrants Low
Threat of Substitute Products High
Bargaining Power of Buyers Moderate-High
Bargaining Power of Suppliers Low
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Rivalry Among Existing Firms
The men’s specialty retail clothing industry is moderately competitive. The
challenges firms face in this industry are continued growth by leading firms, offering of
products and services are similar, and low switching costs for customers. In order to be
profitable, firms must be able minimize costs by making the supply chain more efficient
and attracting customers from other competitors to gain a large part of the market
share. Less significant challenges facing the industry include the high concentration of
a few main firms, the large economies of scale, a low ratio of fixed costs to variable
costs, easily controllable excess capacity, and little barriers for exit.
Industry Growth
* Percentages based on Men’s Wearhouse, Jos. A. Bank, and Nordstrom’s sales growth.
Industry growth plays an important role for companies within an industry to
compete on incoming market share. However, firms in industries with a seemingly
constant effort to grow must constantly fight for market share from its competitors. As
firms grow and add stores, the rest of the industry must follow suit to maintain pace.
Because growth within the men’s specialty retail industry is constant, there is a
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competition to find new markets and store locations. Firms already within the industry
either consume smaller companies in the industry and by default gain the small
competitors customer base, or these firms take away a large competitors market share
by tailoring to the competitor’s customers’ specific needs. Firms who excel in this
industry retain their customers as well as spending large amounts of money on
advertising to win over potential customers. The Men’s Wearhouse plans to add around
21 new stores in 2007 trying to increase their growth and revenue (Men’s Wearhouse
10K 2007).
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Concentration
* Percentages based on Men’s Wearhouse, Jos. A. Bank, and Nordstrom’s sales growth.
The concentration of an industry refers to the number of firms in an industry
compared to the relative size of the market shares that the firms possess. The relative
concentration within an industry affects how the firms compete with one another. If
there are a few large companies controlling an industry, these companies can
coordinate prices and influence to some extent other firms’ competitive moves. If
industry concentration is low, these industries are said to be in an efficient market. The
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men’s specialty retail industry is fairly competitive market with a few large companies
that can set the standards for this particular industry. With few main players such as
Men’s Wearhouse, JoS. A. Bank, Brooks Brothers, and some department stores, these
firms are more worried about what each of these above named competitors are doing
to gain a competitive advantage rather than the threat of new entrants into the market.
For example, currently Nordstrom Inc. has a market cap of $8.1 billion, Jos. A. Bank has
a market cap of $463.1 million, and the Men’s Wearhouse has a market cap of $2.1
billion (finance.yahoo.com). Nordstrom Inc. and the Men’s Wearhouse are in the top 10
largest apparel companies in the nation. However the Men’s Wearhouse and Jos. A.
Bank is specifically men’s clothing, focusing on suits and formal wear. This sector is just
a portion of Nordstrum Inc., therefore these three large companies make up the bulk of
the industry. Because of the relatively high concentration of the market, competition
for market share is extremely intense.
Differentiation and Switching Costs
Differentiation among existing firms is what makes a firm stand out from the
competition. In the men’s specialty retail industry, firms offer the basic same products
as each of the already existing competitors. For example, the main competitors in this
industry all offer suits, sports coats, dress shirts, ties, sportswear, outerwear, and
shoes. What sets a firm apart in this industry includes the quality of the brand that
each firm sells, the price at which the firm is selling a particular brand, and the ability of
the firm to tailor to a customer’s specific needs. All of these differentiation factors take
part in the extent to avoid head on competition to be able to successfully compete in
this industry.
Switching costs of an industry refer to the ease in which a firm can change the
way they are using their inventory, manufacturing plants, raw materials, and other
resources. If it is inexpensive for a firm to change the use of their resources, switching
costs are low and this firm would be able to cater demanded goods to their customers
much more efficiently. In the case of the men’s retail industry, switching costs would be
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very high. There are only so many clothing items a firm can produce for men out of the
same fabric.
Fixed Costs to Variable Costs Ratio
2002 2003 2004 2005 2006
Jos. A Bank 0.503 0.476 0.501 0.655 0.572
Men’s Wearhouse 0.584 0.575 0.640 0.647 0.646
The fixed-variable cost ratio also plays a vital role in the competition among firms
in an industry to reduce their prices to utilize their installed capacity. Companies with
high fixed-variable cost ratios tend to be locked into an industry with large barriers to
exit. Because firms within the men’s specialty retail industry deal with extremely low
fixed to variable cost ratios, it is easy for companies to leave the industry whenever
they opt to get out. Firms in the men’s specialty retail industry are not tied down to a
particular industry, but they also cannot use their fixed assets for alternative purposes.
The higher the fixed to variable cost ratio, the hard it is for a firm to switch the use of
their variable assets. Both Jos. A. Bank have and the Men’s Wearhouse have a high
ratio.
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Scale Economies
Total Assets (in thousands)
2002 2003 2004 2005 2006
Jos. A. Bank $108,457 $136,132 $200,645 $233,304 $304,832
Men’s Wearhouse $769,313 $878,127 $993,322 $1,123,274 $1,096,952
The size of a company relative to its competitors is in important factor in
retaining and gaining a larger portion of the market share of an industry. It is easy for
a firm to compete at a local level within the men’s specialty retail industry, but difficult
for a firm to make it into serious competition with the larger competitors at a national
level. Firms will have difficulty attracting customers and gaining market share at large
scale competition. Incoming entrants will have to meet the standards set by Men’s
Wearhouse and JoS. A. Bank to compete in the men’s specialty retail industry on a
large, nationwide scale.
Conclusion
The men’s retail apparel industry has moderately high rivalry among existing
firms. Firms continue to fight each other for market share by finding new markets and
opening new store locations. Also, the high concentration in the industry increases the
battle for customers. Although Nordstrom Inc. has a huge percentage of the market,
they are a department store that offers more than men’s dress clothes. Jos. A. Bank
and the Men’s Wearhouse sell men’s clothes and these two stores are the largest
percent of their industry. Next, differentiation between the inventories of Jos. A. Bank
and the Men’s Wearhouse is very low which leads to high competition. Finally, both the
Men’s Wearhouse and Jos. A. Bank have high switching cost and relatively high fixed to
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variable cost ratios which create large industry exit barriers. Each firm works hard to
distinguish their goods and gain a competitive advantage.
Threat of New Entrants
The apparel industry is very established, especially the men’s sector. Even
though many brands and designers exist, a few large companies dominate the retail. As
previously stated, the leading companies in the men’s apparel industry have been
around for decades, and there are many barriers of entry for a new firm such as scale
economies, the first mover advantage, distribution access, relationships in the market,
and legal barriers.
Scale Economies
Total Assets (in thousands)
2002 2003 2004 2005 2006
Jos. A. Bank $108,457 $136,132 $200,645 $233,304 $304,832
Men’s Wearhouse $769,313 $878,127 $993,322 $1,123,274 $1,096,952
In the apparel industry, there is a large economy of scale when producing men’s
wear. Men’s fashion is very one dimensional compared to women’s clothing. For the
most part, men wear pants, shirts, jackets, and shorts. Many of these products are
made from the same fabric, thus a larger company can purchase fabrics and
manufacture clothes in bulk to lower their per unit cost structure, giving a larger
company an advantage in the industry. This makes it very difficult for any new
company to enter the men’s apparel industry, and any new firm would be operating at
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a deficit for an extended time period until they secured their market share and proved
their competitive advantage. Also, the men’s apparel industry is very competitive. A
customer has many choices to consider when buying their clothes. However, a handful
of large firms flood the industry. In 2007, the Men’s Wearhouse had $2.13 billion in
revenue and a net income of $184.55 million, and Jos. A. Bank had $577.43 million in
revenue and a net income of $46.9 million (finance.yahoo.com). Even Brooks Brothers,
a smaller privately held company had $260.2 million in revenue as of 2007
(finance.yahoo.com). If new firms attempt to enter the market, larger companies have
the ability to drop their prices so low that most consumers would not be able to justify
buying a new product. A new company would not be able to compete with the low
prices because their costs of production are not spread out enough and the firm would
go under. The larger the company and the lower the unit costs, the more longevity a
firm will have in the market.
First Mover Advantage
Leading the industry in innovation and being first to make arrangements in the
retail industry is extremely important. However, with the somewhat stagnant state of
the men’s apparel sector of retail, the first mover advantage does not play a big role in
deterring new firms. The only advantage that could be attained would be special
arrangements with new material suppliers or cheaper labor costs at an overseas
factory. Although the technology boom in the past decade has helped lower the cost of
production in the apparel industry, it has not lead to any significant advances or
changes in the clothes men wear today. Clothes are necessary goods and are very basic
in their purpose. Therefore, breakthrough technological innovations in men’s clothing
really do not exist.
Access to Channels of Distribution and Relationships
Once a new firm has designed a product and produced goods, now they must
sell it. In order to sell it they must physically get the apparel in front of the customers.
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This difficult task involves two important factors. First, the new firm must attain shelf
space, and secondly the firm needs a distribution network to deliver the goods to the
stores. JoS. A Bank has their own centralized distribution system in Hampstead,
Maryland, where all merchandise is received from the factories, processed, and
distributed to their own stores (marketwatch.com). JoS. A Bank and The Men’s
Wearhouse have their own retail stores; therefore they have no problem finding shelf
space for their apparel. However a new company may have to sell their goods in a
department store where they must compete for top shelf space. Shelf space is vital to
the sale of goods, and could make or break a company. Working to obtain top shelf
space requires developing relationships in the industry. All established designers and
apparel companies have already created these key relationships that have lead to their
success and establishment in the industry, and building a new alliance with a retailer
may be challenging. This relationship is based on making money and to form these
bonds may include a monetary award in exchange for shelf space. For example, The
Men’s Wearhouse purchases merchandise from over 800 venders for their stores
(marketwatch.com). They have formed hundreds of relationships with vendors
throughout the life of their company, and a new firm would be way behind.
Legal Barriers
Many industries in the U.S. are very highly regulated by the Federal Government;
the apparel industry is not one. Starting an apparel label or company is very simple.
Several small designers exist around the U.S. that do not receive much exposure or
sales. However, some states such as California do have regulations on consumer
products they believe extended exposure may cause cancer. Proposition 65 in California
requires businesses to provide warnings to the consumer if their goods expose the
buyer to any of the 750 substances the state has deemed hazardous and cancer
causing (American Apparel and Footwear Association). But this is an obstacle that all
clothing manufactures and designers must face, and would not solely limit one company
from entering the market.
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Threat of Substitute Products
In a highly competitive market such as the apparel retail industry, there will
always be the threat of substitute goods. In men’s apparel, every designer and
company are all making shirts, pants, shorts, jackets, and clothing accessories. Each
label attempts to differentiate their product through price, quality, and performance.
Relative Price and Performance
Price levels of consumer goods are a very sensitive aspect of selling products.
Prices are too high and not enough people are able to afford a good, but price the
goods too low and it may be labeled cheap and not worthy of a consumer’s money. For
example, JoS. A Bank had an online sale of a gray suit normally priced at $500, selling
for $200 (josabank.com). Men’s Wearhouse had a comparable suit on sale two suits for
$200 (menswearhouse.com). A consumer’s might initially like the idea of their money
going farther, but are they sacrificing quality for quantity? This may cause a buyer to
consider Men’s Wearhouse suits are made cheaper. Also, if a firm sells a product that
lasts longer than the industry standard, the consumer loses the need to buy repeat
goods as often and a firm may lose business.
Buyers’ Willingness to Switch
A buyers’ willingness to switch is based on loyalty and value. If a consumer has
grown up buying their suits from Nordstrom’s, why would he change? However if a
consumer feels that a cheaper substitute good satisfies their performance standards,
buying the less expensive good is justified.
Bargaining Power of Customers
Bargaining Power of customers is the customer’s power in comparison to the
power of the industry. Relative Bargaining Power is the ability of either the customer or
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the company to survive without doing business with one another. When exploring
bargaining power, it is obvious that the retail industry cannot do business without the
consumer. When analyzing the bargaining power of customer, one must evaluate at
the size of both the industry and the customer base. Also, one must analyze the
differentiation of companies in the industry, price control, and switching cost.
Technology must also be considered when evaluating customers as well because new
technology brings about new issues to the forefront of all retail companies.
Technology creates a smarter shopper that gives them the upper hand in many
ways when the industry is constantly changing. The internet has become the customer’s
greatest tool to increase their buying power. It has changed the way people shop
today. Customers can gain a greater knowledge about a company before ever stepping
foot in a store. It can help people understand a firm’s reputation and the products that
they offer. Also, the internet is making it much easier for the customer to use as an
alternative instead of physically walking into a company’s store. A simple search engine
can provide the customer with many substitutes at the click of a mouse. Marketing
techniques are much less effective as shoppers begin to make their own decisions while
searching on the internet. Although the internet has allowed many companies to grow
in size and increase their customer base, new technology has given the customer the
upper hand in bargaining power.
Price Sensitivity
The cost for customers to switch retailers is extremely low. It is incredibly easy
for a consumer to switch from buying similar products from companies within an
industry. With little or no cost for the customer, companies must differentiate their
offerings to make their store the first choice first choice for customers. The dilemma
with the growing use of the internet is also helping customers in their purchasing
power. As stated previously, the internet transforms customers to become smarter
shoppers, and the industry now offers many options for the customer.
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The customer has relatively low power to change the prices in specialty men’s
retail. The prices are set by supply and demand in a purely competitive market such as
this market. As was said before, customers have a growing power over companies
which means companies must work very hard to ensure a strong customer base.
Customer satisfaction and loyalty are the most effective and important ways in keeping
and attracting new customers.
Differentiation
The retail market is an extremely hard market in which to differentiate. While
some stores can offer tailoring and brand labels, these offerings are only a few aspects
that customers appreciate out of the competition. This makes it hard for stores to
stand out as the consumer’s first choice of retail store. Without this differentiation,
stores will find it extremely hard to succeed. Companies can focus their differentiation
in personal relationships with customers. Customers today appreciate the values of their
choice in men’s retail stores. "Our research makes it clear that companies that
understand the `human values'-based needs of today's consumer and offer sharp
differentiation combined with promise execution can develop a value proposition that is
meaningful to the new global consumer," said Fred Crawford, Executive Vice President
of Cap Gemini Ernst & Young's Consumer Products, Retail and Distribution practice.
With the growing concern of the customer power, it would be wise to say that
the customer has strong bargaining power over the industry. While not in every aspect
such as price control, the customer has complete control over their choice in retailer.
Technology has made them smarter, which helps make switching even easier.
Switching retailers is nearly cost free. In conclusion bargaining power is not in favor of
the retail industry.
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Bargaining Power of Suppliers
High Bargaining Power of suppliers is not desired for an industry. "Bargaining
Power is high when there are many buyers and few competitors, there are
undifferentiated, highly valued products and suppliers threaten to integrate into their
own retail store"(Tutor2u.net). Unlike customers to a business, neither suppliers nor
the company can survive without the operations from one another.
Number and Volume of Suppliers
Power of suppliers is high when there are many more dominant companies and
fewer suppliers. One factor that is making the power of suppliers weaker is the ease
access to cheaper overseas suppliers. Globalization has opened up so many
opportunities, including a broader access to many companies that US suppliers find it
hard to compete with. Bargaining Power of suppliers is also thinning due to companies
reducing capacity. When companies reduce capacity and narrow their competition,
their choices suppliers have is also narrowed. For example if stores limit the brands and
the space they have in stores, they can extract bigger competition for brands to get
their name in their stores. These factors have made the suppliers the minority, giving
them less bargaining power while companies have many more choices of suppliers than
before. Some suppliers and companies have established exclusive partnerships to
ensure the stability of the supplier and to make sure that the company is being
continually supplied with products to offer customers. For example AT&T and Apple
have made their partnership final. This has allowed AT&T to win with guaranteed
manufacturer supply of Apple cell phones and the opportunity to earn billions of dollars
in revenue. On the other hand we have the area of specialty stores that have their own
problem with suppliers. The number of suppliers actually narrows when dealing with the
higher end retail stores carrying name brands. Because a firm’s selection has become
more specific, so has the selection of outlets that suppliers can provide these brands
and high quality apparel. Though this section of the retail industry is smaller than the
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generic section, this characteristic weighs down the volume power the industry as a
whole has over the suppliers.
Price Sensitivity
Switching costs is the actual cost to the supplier to switch producing products for
a particular company. It is also the relative ease of finding new customers. When
switching costs are low, it raises the bargaining power. When switching costs are high
or switching to supply a different company is difficult, significant bargaining power of
the supplier decreases. Supplier’s ability to switch companies within the men’s specialty
retail industry is reasonably simple. While there are more suppliers to choose from,
there is definitely no shortage of stores wanting manufacturers. Likewise the ability of
companies to switch suppliers is easier. Suppliers only business comes from companies
and usually suppliers welcome new business. In all, when considering switching costs,
the supplier has a low bargaining power over the industry.
Differentiation
As we said earlier, there is an area of smaller, higher end stores that are
differentiated by their name brand products. This gives some suppliers an edge because
these stores can only use specific suppliers. When a company has a differentiated
product that is critical to the success of the business, the company’s supplier will have
an upper hand when determining bargaining power. Therefore when exploring
differentiation of the suppliers to an industry, one can see that these suppliers have the
bargaining power.
Several different issues play a deciding factor in determining who has more
control in this industry. Technology has given the customer more power in choosing
their choice retailer. It has also caused for a larger possibility of forward integration.
Manufacturers of goods can sell directly to the customer as opposed to selling to retail
stores, leaving the retailers out all together. The threat of possible forward integration
gives suppliers more power, but they still remain the less dominant. In general, the
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majority of the men’s retail industry does not have specific undifferentiated products. As
we said before, firms are more powerful when there are more suppliers and that is the
case in the retail industry. In conclusion, stores have more relative bargaining power
over suppliers.
Value Chain Analysis
Overall Classification of the Industry
It is important to reiterate how Men’s Wearhouse has been classified in the retail
industry. They comprise the following: moderate to high rivalry amongst existing firms,
a low threat of new entrants, a high threat of substitute products, moderate to high
bargaining power of customers, and low bargaining power of suppliers. There are
three significant elements that require specific attention. First, we need to recognize
the high economies of scale that exist in this specific industry. It is hard to break into
the men’s retail industry and gain a large part of market share because there are
already large existing firms. Secondly, the men’s retail industry is highly concentrated,
creating strong competition for market share. Finally, the relationship established with
distributors plays an important role in a company’s success. It is crucial to maintain a
substantial relationship with a distributor to ensure dependability. A company’s
distribution infrastructure is the core of organizational success.
Value Chain
The procedures that firms chose to execute in order to create value for their
company is referred to as the value chain. Every firm in an industry must identify their
competitive advantage and base their business strategy on this advantage to ensure
success. It is important to make sure the chosen strategies are applied to the proper
area. By understanding the value chain of an industry, one can understand important
aspects of a firm that lead to success.
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Competitive Strategies
In order for a firm to be successful in this specialty retail industry, each firm
must strategically chose ways to position itself. The key competitive strategies firms
must distinguish themselves between are differentiation and cost leadership. Some
firms chose one versus the other, but a combination of both of these strategies is vital
in the men’s retail industry. Cost leadership is important in this industry primarily
because it is so highly concentrated. The ability to generate a lower cost from
supplying the same products and services as your competitors is essential. Therefore,
low-cost distribution and economies of scale and scope must be taken advantage of.
When determining how to differentiate your company in such an industry, one can
benefit from superior customer service, investment in brand image, and superior
product variety.
Cost Leadership
Low-Cost Distribution
One important approach to being a cost leader in this industry is to minimize
distribution cost. Centralized distribution centers are needed because the scale of each
firm is so large in this industry. It helps ease communication and allows for much
better organization among the firm. The same products are carried at every location.
Therefore, it is only necessary to fund one distribution center that will allocate the
proper products and quantities to each location. This cuts down on the cost of
maintaining land and buildings for these purposes. Centralized distribution also allows
for easy transportation methods. For example, a firm may be able to reduce the cost of
relocating merchandise through the use of their own hauling.
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Economies of Scale and Scope
New Store Openings
Economies of scale is somewhat easy to achieve for firms in this specialty
industry because there so few of them. It is also a very important priority because it
helps firms gain market share. These firms compete so greatly on price. Therefore,
they must concentrate on minimizing internal costs. The high competition created from
high concentration in this industry provokes firms to expand their scale of operations.
This increase in the scale of the firm creates a decrease in the average cost in the long
run. In 2006, Jos. A. Bank had 318 store in operation, while the Men’s Wearhouse had
543 (businessweek.com). Firms in this specific industry have an advantage in terms of
supplier relations because they are very large and have been established for a long
time. As the graph shows both the Men’s Wearhouse and Jos. A. Bank are adding store
locations and increasing their economies of scale, thus reducing their per unit cost. The
clothing in this industry is very standard and maintains the same trends year after
year. This allows for firms to buy in bulk. As a result of purchasing large quantities of
merchandise at one time, firms are more likely to receive discounts. This also allows
firms to reduce the product price that is needed to turn a profit. The concept of
economies of scope focuses on the changes in demand of a firm. A more established
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firm that offers many different product lines and styles would be able to withstand a
failed product line because the firm’s other successful items would ensure positive
company sales. For example, a firm may offer a traditional line, modern style, striped,
and solid dress shirts. If the demand for the modern, striped, and solid flourished and
few customers purchased the traditional line, a company could still be successful.
Differentiation
Superior Product Variety
It is extremely important for firms to differentiate their products and services in
such an industry because every firm carries the same type of merchandise. Each firm
must find ways to set itself apart. Superior product variety is a technique that is widely
used among this industry. It is essential to apply the concept of giving customers many
options by having a depth of selection. This does not only apply to providing a
selection of different types of apparel and accessories, but brands and product services
as well. For example, product services that are indispensable may be rental or dry
cleaning services. This is what can ultimately set a company apart from their
competitors in this industry. However this is very difficult to measure. A customer may
like the selection that Jos. A. Banks has to offer versus the Men’s Wearhouse. Only by
shopping at both stores could one form a personal opinion on the superior product
variety. However, the Men’s Wearhouse has relationships with approximately 800
venders that they retail in their stores (themenswearhouse.com). On the other hand
Jos. A. Bank sells only their products in their stores. It could be assumed that the Men’s
Wearhouse has a larger product variety.
Superior Customer Service
Another differentiation tactic that is simple, but necessary in order to be
successful in the retail industry is superior customer service. It is important to use
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customer service for the purposes of: in-store assistance, catering to questions,
following up with customers, and, custom alterations. Customer satisfaction is obtained
by making customers feel welcome and showing them you care about their needs as a
consumer. Some firms in the retail industry have specific customer service desks and
specialized clothing consultants. Great customer service is beneficial in the long run
because it helps maintain lasting relationships with customers. Repeat buyers are a
huge part of the retail industry. This is also a hard factor to measure. Only through a
customer survey performed by an independent party or by personal experience can one
form an opinion on the best customer service in the industry. Both Jos. A. Bank and the
Men’s Wearhouse offer customization to their suits and dress clothing so that the cloths
fit each customer.
Investment in Brand Image
Investment in brand image is a significant method of differentiation, especially in
an industry where most of the products are the same. Firms will make contracts with
product label companies to sell their brands. In doing so, they are given the
opportunity to market their own company easily. It is helpful to invest in certain brands
to target specific consumers to bring them into the store. Then a firm has the
opportunity to appeal to a customer’s needs and wants on a higher level than just
brand image. Also effective advertising campaigns can change a firm’s brand image.
The obvious image a men’s dress wear retailer would want is a sophisticated upper-
class look. However, the prices of the goods each firm is selling can also be a large
factor in brand image. Price a suit too low, and it may deter buyers seeking high-end
clothing. Yet if a firm used high-profile business men, actors, or athletes to project their
company image, they may be able to overcome a cheap image.
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Competitive Advantage
The Men’s Wearhouse has been successful over the years due to their position in
the men’s specialty retail industry. They offer many quality products and services that
allow the company to differentiate themselves from other major retailers and capture
the competitive advantage that the vast majority of retailers neglect to address while
offering a lower cost.
Cost Leadership
The Men’s Wearhouse has sustained many years of growth because they have
captured the industry by selling a product and service at a lower cost than their
competitors. They have setup trade agreements with clothing manufacturers and have
passed on their added savings to their customers (themenswearhouse.com). Not only
does this successfully give the market a quality product and service at an agreeable
price, but it also drives down the competition’s margins in order to sustain acceptable
levels of market-share. Thus, new entrants are also discouraged to enter a market
where profits are small due to economies of scale, lower production costs, and value
chains are continually being scrutinized for added efficiency.
Economies of Scale
In the United States in 2006, the Men’s Wearhouse averaged a new store a
week. Any business on this scale creates a bundle of difficulties for their competition.
Existing competitors as well as new entrants have to constantly adapt to keep up with a
company of this magnitude. With new stores emerging all over the U.S., Men’s
Wearhouse can continue to order product in such large bulk that they receive a growing
discounted rate from the manufacturers. Therefore, the competition is forced to lower
their prices, either cutting their margins below projected levels, or driving them out of
the industry.
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Economies of Scope
Advertising is one key element to Men’s Wearhouse success through economies
of scope. When a company stretches its advertising over large geographical markets, it
lowers its long run average costs, thus being able to reduce prices even further.
The Men’s Wearhouse creates another example of economies of scope with the
many different product lines. If one of their product lines were to fail due to a decline in
popularity, a manufacturer experiences exceptional losses or litigation impedes the
production process of its respected product, the company has essentially diversified
their business and will be less likely to be susceptible to failure. Many firms that
experience economies of scale and scope are often defined as a natural monopoly,
because it is more efficient for one firm to expand than for new firms to be created.
(http://en.wikipedia.org)
Differentiation
Another major key component to the Men’s Wearhouse ability to maintain a high
percentage of market-share is their ability to differentiate themselves amongst their
competitors. They sell high quality clothing and accessories that customers identify and
appreciate. Their 1,200 stores offer everything from silk ties, Italian leather shoes, to
high-end tuxedos.
Along with these featured products, the Men’s Wearhouse provides many
services that many of their competitors overlook. One major element that keeps Men’s
Wearhouse ahead of the competition is that they employ “wardrobe consultants” who
cater to each individual’s needs, taste, and budget. This greatly benefits the customer
who wants to look their best, ensuring a quality fit. They also address any last minute
tailoring, free re-alterations for those needing adjustments over the years, free lifetime
pressing of any suit, tuxedo, sport coat, or slacks, and minor repairs involving buttons
and zippers (www.menswearhouse.com). Equally impressive, the Men’s Wearhouse has
a delivery service that will deliver any garment to one’s office. In 1999 Men’s
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Wearhouse began their tuxedo rental program, capitalizing on wedding and prom
seasonal months. Offering rentals gives the Men’s Wearhouse another window of
opportunity by selling a service to those who need the flexibility of either choosing to
buy a tuxedo or renting a garment for a one-time occasion.
Other notable services are the afterhours alterations, and dry cleaning services
associated with their customer’s needs. The Men’s Wearhouse plans to open seven new
dry-cleaning stores in the Houston area throughout 2007.
Input Costs
One reason The Men’s Wearhouse has achieved constant growth is by controlling
their input costs. At any given time throughout the year 2007, the Men’s Wearhouse
retained approximately 800 vendors in which they have developed solid relationships
with their bank of suppliers by utilizing regular and steady purchasing practices
involving no long-term contracts (themenswearhouse.com). This leaves the company
not tied down to any one vendor who may deviate away from the Men’s Wearhouse
core principles of being able to offer their products 20-30% cheaper than their
competition. Another cost benefit that the Men’s Wearhouse receives is that they do
not request cooperative advertising support from the manufacturers. In addition, the
Men’s Wearhouse is given a discount for preordering a specified quantity of items well
in advance of the major revenue generating seasons. Once again, preordering lowers
the cost of the manufacturer doing business with the Men’s Wearhouse, allowing those
savings to essentially be passed to the end customer.
Another major component that allows The Men’s Wearhouse to enjoy substantial
profits is that they generally operate on a small budget. All of the Men’s Wearhouse
stores and distribution vehicles are leased. This allows the company to continue
growing quickly without raising a lot of capital for each additional store. The company
can use this additional funding for research and development, expansion, or rewarding
shareholders by issuing dividends or stock splits.
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First Mover Advantage
The Men’s Wearhouse was the first company to offer low prices on suits but still
offer free quality customized alterations. This is an important selling point for the Men’s
Wearhouse. A potential customer may choose to schedule an appointment with a
wardrobe consultant to be personally fit for their needs, budget, and taste
(menswearhouse.com). Also, the Men’s Wearhouse will personally deliver your custom
clothes to your office if needed (menswearhouse.com). The Men’s Wearhouse is the
leader in customer service regardless of the price of the suit.
Image
In 1975 Men’s Wearhouse aired their first commercial and the television public
got its first image of what Men’s Wearhouse was all about. George Zimmer’s “I
guarantee it” was introduced and gave watchers the idea of a reliable company. It is
often hard to maintain a respectable discount name brand store and Men’s Wearhouse
has done just that. While offering discounts of around 20%, they still hold the image of
a high end store that attracts a wide variety of incomes. They target, “middle and
upper-middle income men”. (www.menswearhouse.com). Men’s Wearhouse advertising
uses George Zimmer to give a personal feel to their company. They use models that will
attract the everyday business man, the family man, and even the black tie man. Using
this variety of models gives the customer the feel that this store is for them, no matter
which lifestyle they live. From their personal and genuine commercials targeting every
male, to their classically laid out webpage, Men’s Wearhouse remains a highly regarded
specialty store with a remarkable image.
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Accounting Analysis
Financial statements are provided to shareholders or potential future investors
with the information needed to value a firm. These financial statements answer specific
questions an investor may have by presenting how the business is currently operating
and what the future prospects for the company may be. By giving them this
information, they are better able to make an informed decision about whether to invest
in the company or to provide the financing needed for the firm’s future investment
plans. Although all firms must abide by the Generally Accepted Accounting Principles
(GAAP), GAAP allows for much flexibility in the way that a firm may report their
financials. Analysts must look at these financials with skepticism to be able to observe
an unbiased view of the company at hand. Management has been given some slack in
the way that they report their financials to be able give shareholders or future potential
shareholders a more transparent view of the company, helping the shareholders to
understand more about how the company operates. The accounting analysis allows
analysts to determine the accuracy of the information reported by a firm and to
investigate the extent of these errors made by the firm when reporting its financials.
The accounting analysis is a six step process. First, analysts must identify
principal accounting policies that may be influenced by a particular firm’s competitive
strategy or other key success factors. To ensure that a firm is properly valued, analysts
should identify and assess the policies and the estimates the business exercises to
measure its key success factors and risks. Next, analysts must assess the possible
amount of flexibility that is allowed by GAAP. After the flexibility has been identified for
the firm, analysts can then compare this particular firms’ accounting strategy with other
firms within the industry. Then, analysts evaluate the quality of the disclosure to
determine how transparent the financial statements of a firm really are. If any
discrepancies appear, analysts further investigate these “red flags”. Once the “red
flags” have been identified, analysts must undo any accounting distortions to accurately
value the firm to be able to compare the firm with its competitors.
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Key Accounting Policies
When analysts identify a company’s key accounting policies they must make sure
that the firm’s principles directly correlate to their key success factors. For analysts to
identify a company’s key success factors, they must link the company’s accounting
disclosure to these key principles. Using the five forces model, we have established the
key success factors of Men’s Wearhouse to be economies of scale and tight cost
control. The recognition of these success factors is important because they are what
distinguish a company’s competitive advantage. As a result of low differentiation
among the products in this retail industry, companies strive to gain competitive
advantage to set themselves apart from others in any way feasible. Economies of
scale are achieved as a result of high competition. The men’s retail industry is highly
concentrated. Therefore, price competition has driven Men’s Wearhouse to expand
their scale of operations. In doing so, they continue to order their products in bulk at a
discounted rate; forcing competition to lower prices. Tight cost control is demonstrated
through the utilization of low-cost distribution and low input costs. These factors allow
Men’s Wearhouse to save on real estate costs and cut their prices, respectively.
Aside from identifying key accounting policies, it is also important for firms to
make estimates about the future. This is necessary in order for management to
measure their own risks and critical success factors. The key accounting policies that
determine how Men’s Wearhouse executes their key success factors are the following:
health benefit costs and workers’ compensation and operating versus capital leases.
Pension Liabilities: Health Benefit Costs & Worker’s Compensation
Firms must implement and sustain low costs in the men’s retail industry. If firms
are unable to do so, they must present their financial data in a less transparent way.
They must present the data in such a way that investors think their costs are lower than
they might actually be. All firms must account for their own benefit plan pension
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liabilities. This is an area that is often distorted to make costs look better than they
really are.
The pension liability program offered to Men’s Wearhouse employees consists of
employee health benefit costs and self-insured workers’ compensation. They estimate
the what their future payments should be, “…based on historical experience and various
assumptions as to participating employees, health care costs, number of claims and
other factors, including industry trends and information provided to us by our insurance
broker” (Men’s Wearhouse 2007 10K). Actuarial estimates are made in regards to
workers’ compensation. If the actual costs exceed their estimates, they add the
necessary charges to their earnings to be correctly accounted for.
Men’s Wearhouse also offers retirement funds to employees. These are disclosed
as “Asset Retirement Obligations.” Men’s Wearhouse is legally obligated to complete an
asset retirement activity “even if the timing and/or settlement are conditional on a
future event that may or may not be within the control of an entity” (Men’s Wearhouse
2007 10K). As long as the fair value of the obligation can be estimated in a reasonable
manner, a liability must be recorded.
Operating and Capital Leases
Firms in this industry must decide whether their lease arrangement will be an
operating or a capital lease, The conditions for reporting leases create possibilities for
management to get around distinguishing between capital leases and operating leases.
When companies do this, their assets are understated. Most firms in the men’s retail
industry primarily exercise operating leases. This type of lease is expensed on the
income statement; thus, reducing liabilities by staying off of the balance sheet. Costs
are not fully recognized, allowing for firms to appear more cost efficient than
competitors who use capital leases.
Men’s Wearhouse uses an operating lease as their lease arrangement. They
account for their operating lease as a rent expense, understating their liabilities and
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assets by $81.4 million in which their total assets equal $1 billion. This misstatement
on the balance sheet occurs because Men’s Wearhouse does not own their buildings;
they lease them from the individual building owners. The term of the lease (in most
cases between five and ten years) in addition to the first renewal option period is
calculated on a straight line basis. This calculation valuates the total for rent expense.
Before the fiscal year of 2006, the Men’s Wearhouse, “…capitalized rent amounts
allocated to the construction period for leased properties as leasehold improvements”
(Men’s Wearhouse 2007 10K). However, during 2006, they adopted a new FSP from
the FASB, “which requires that rental costs associated with ground or building operating
leases that are incurred during a construction period be recognized as rental expense”
(Men’s Wearhouse 2007 10K).
Potential Accounting Flexibility
The purpose of financial reports is to provide credible information to investors
regarding the economic consequences of the individual firm’s business activities. It is
necessary for firms to have flexibility in reporting financial data so that the information
is informative. The Generally Accepted Accounting Principles offer a variety of
accounting procedures that firms can chose to use. Firms are able to present the
information needed to achieve specific purposes to target different audiences.
(en.wikipedia.org). Managers are generally given more flexibility through the GAAP
when disclosing their firm’s key accounting policies, than when disclosing their firm’s
key success factors. Although flexibility is necessary, it can also influence firms to
distort their financial statements to seem more appealing to investors. The following
discusses how flexibility affects the accounting methods for the Men’s Wearhouse.
Pension Liabilities
Firms have many options as to what post-retirement and pension liability
programs to offer. Factors that contribute to the benefits a firm offers are the
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following: expected return on plan assets, discount rate for liabilities, and rate of
increase in wages and health care costs (Palepu & Healy). Firms will incorporate
different factors into estimating how much of a liability they will undergo. For instance,
the Men’s Wearhouse uses “…participating employees, health care costs, number of
claims and other factors, including industry trends and information provided to us by
our insurance broker” (Men’s Wearhouse 2007 10K). Through the flexibility of the
GAAP, it is easy for firms to overstate earnings. They use their pension costs to adjust
for these additional earnings. It is important to determine whether a company offers
defined benefit or defined contribution pension plans. Men’s Wearhouse offers a
defined benefit plan. They provide a defined benefit plan by offering a specific monthly
benefit at retirement. Men’s Wearhouse has committed to post-retirement obligations
that have to do with planned assets. A liability is only recorded if they are able to
reasonably estimate the fair value of the obligation (Men’s Wearhouse 2007 10K).
Capital versus Operating Leases
All firms are given great flexibility in determining whether to apply capital leases
or operating leases. An operating lease is a rental contract, and a capital lease is
corresponding to ownership. Men’s Wearhouse has chosen to apply operating leases on
a straight line basis. In fiscal year 2005, Men’s Wearhouse chose to change how they
recorded rental costs incurred during construction periods. They went from recording
these costs as leasehold improvements to recording them as rent expense. The effect
of this change in “fiscal 2006 was approximately $2.2 million of additional expense”
(Men’s Wearhouse 2007 10K). As a result of this change, these costs are shown on
the income statement as expenses, rather than on the balance sheet as liabilities.
However, deferred rent is recorded on the balance sheet as other liabilities. “Landlord
incentives received for reimbursement of leasehold improvements are recorded as
deferred rent and amortized as a reduction to rent expense over the term of the lease”
(Men’s Wearhouse 2007 10K).
43
Actual Accounting Strategy
Financial Statements all disclose helpful information, but they can come in
different levels of disclosure. Accounting strategies can be aggressive with high
disclosure or conservative with only the minimum to satisfy the GAAP or generally
accepted accounting principles. Usually, the more aggressive the strategy, the more a
viewer can tell about the status of a firm. This flexibility that firms can use will either let
them better describe their financial state or they can avoid disclosing certain
information that may be unfavorable to those using the statements.
The Men’s Wearhouse abides by generally accepted accounting principles when
disclosing financial statements. They disclose minimal information about the business
of their key accounting policies; making it more difficult to assess the value of the
company. This may cause analysts to have to predict and estimate certain amounts
when recording these statements, causing a discrepancy between actual numbers and
those reported. Men’s Wearhouse discloses inventory as a key accounting estimate in
their annual filing. “Inventory is carried at the lower of cost or market”
(www.menswearhouse.com). The inventory also includes the distribution costs, which
may have to be estimated. Men’s Wearhouse discusses the fact that statements must
also consider lost or damaged inventory. This may cause the need to markdown prices
or the actual loss of profit for that section of inventory. This is one area where
numbers could differ. Because ratios of inventory are used, this could also cause
numbers to differ in costs of sales.
As we said earlier, the Men’s Wearhouse must estimate in critical areas. They
consider the estimates with the most effect to be inventories, which we just discussed,
and long lived assets. Long lived assets would be “goodwill, estimated liabilities for the
self insured portions of workers’ compensation and employee health benefit costs,
income taxes, and operating lease accounting.” (www.Menswearhouse.com)
44
Over the years, Men’s Wearhouse has changed certain policies that have affected
the accounting estimates that pertain to specific key success factors. For instance,
their way of recording operating lease changed in 2006. In this year, Men’s
Wearhouse began using the FASB Staff Position 13-1, “Accounting for Rental Costs
Incurred during a Construction Period.” This adoption caused the company to have
about $2.2 million of additional expense to their records. In 2004 they adopted
Statement of Financial Accounting Standards 151 “Inventory Costs” which did not
change their records. Two other adoptions that didn’t have a significant impact on the
statements are FIN 47 and Standards No. 154, “Accounting Changes and Error
Corrections.” Several other changes have been made that have not had an impact or
are still being evaluated. Also in 2004, they took the FASB Position No. FAS 109-2,
“Accounting and Disclosure Guidance for the Foreign Earnings Provision within the
American Jobs Creation Act of 2004. FSP 109-2 provides guidance under FASB
Statement No. 109, Accounting for Income Taxes.”(www.Menswearhouse.com-10k)
After this update, income tax expenses rose an extra $3.9 million causing the earnings
per share to fall by $0.07. As you can see numbers and strategies change and must be
closely analyzed every year. Men’s Wearhouse is exact and clear when communicating
their past and current policies and the effects they have had on their statements.
The flexibility within the GAAP allows firms to be either conservative or
aggressive in choosing key accounting policies. If a firm chooses to be conservative,
their company portrays lower reported earnings. On the other hand, if a company
chooses the aggressive approach, their reported earnings are higher. Men’s
Wearhouse uses a more aggressive approach in order to present higher reported
earnings. They practice this approach by the way they capitalize operating leases.
The fact that these leases are expensed and are not accounted for as liabilities on the
balance sheet results in higher reported earnings.
45
Quality of Disclosure
When firms report their annual results from the most recent year, they want to
make their company look profitable to increase shareholder’s wealth and try to lure
possible investors. Companies sometimes attempt to distort some of their information
released in their annual 10K to make their company look better-off than they actually
have been performing, or they may try to manipulate their reported earnings to look
not as promising as they actually may be in attempt to make the company look as if it is
doing well in future years when the company in fact has underperformed. It is
important that analysts trust that they are getting the best information from the firm’s
reporting in order to have assurance in the firm’s direction.
“Accounting is an information system that provides reports to stakeholders about
the economic activities and condition of a business.” (www.srvbrooks.com). In general,
Men’s Wearhouse reports economic activities and its condition using a more aggressive
approach when recording financial statements. The norm in the retail industry is to use
a moderate accounting strategy. The other retail companies we have looked over use a
blend of conservative methods mixed with a few strategic aggressive approaches that
illustrate their company’s performance and standing. Jos. A. Banks for example is
somewhat more modest when communicating financial information. This is why we
consider Men’s Wearhouse to be on the more aggressive end but still effective and clear
when supplying information to users.
After analyzing the annual 10K’s from the Men’s Wearhouse from years 2002-
2007, one may note that with each successive year the Men’s Wearhouse has begun to
report more and more detailed information about their company. Men’s Wearhouse is
primarily transparent in the data they provide in their 10K regarding their key success
factors. They specifically disclose their key success factors when they say, “We believe
our critical accounting policies and our most significant estimates are those that relate
to inventories and long-lived assets, including goodwill, our estimated liabilities for the
self-insured portions of our workers’ compensation and employee health benefit costs,
46
our income taxes, and our operating lease accounting” (Men’s Wearhouse 2007 10K).
They go on to briefly discuss their disclosure on each of these policies. They do portray
the relation between these policies and their key success factors, economies of scale
and tight cost control. The only policy that is not apparent is the capitalization of
operating leases. This is because they are using their operating leases to distort total
assets and liabilities. Overall, the information that they provide is valuable, however, it
would be much more helpful if they went into greater detail. This observation seems to
be almost parallel with the other companies within the industry. Jos. A. Bank is clearer
when discussing information about their key success factors. The information they
provide is more transparent than the information that Men’s Wearhouse gives.
Therefore, it is easier to interpret the data in Jos. A. Bank’s 10K. They also go into
greater detail when disclosing their accounting policies and estimates. The information
stated in the balance sheet, income statement, and cash flows statement seems to be
unclear and somewhat vague. However, the Men’s Wearhouse also includes lengthy
footnotes referring to each of these specified documents that, in turn, give analysts a
better understanding as to where the numbers in the reported financials are derived
leaving the analyst without having to make many assumptions about the company’s
reporting practices. Most of the information provided in the footnotes seems to be in-
line with what has been stated in the financials. These footnotes simply give more
detail such as with the extra information provided on pension liabilities, lease
obligations, and inventories sections of the 10K.
In the “Other Assets and Accrued Expenses” section of the footnotes, the Men’s
Wearhouse goes on to report accrued salary, bonuses, and vacation; and accrued
worker’s compensation and medical costs as two separate line items under “Accrued
Expenses”. This information gives readers more incite as to exactly what the Men’s
Wearhouse has recorded as part of their accrued expenses. On the other hand, in the
pension liabilities section of the footnotes to the financial statements, the Men’s
Wearhouse refers to these liabilities as “Asset Retirement Obligations”. The Men’s
Wearhouse does not have any reported numbers as to how much they are putting aside
47
or at which discount rate they are using to finance their retired employees’ benefit
plans.
On a more positive note, the footnotes to the Men’s Wearhouse 2007 10K
continue to inform analysts about their future lease obligations. As stated earlier, the
Men’s Wearhouse leases their buildings from a third party which the foundation for their
large dollar value in their future operating lease obligations. The Men’s Wearhouse lays
out the “minimum future rental payments under noncancelable capital and operating
leases as of February 3, 2007 for the next five years and in the aggregate” (Men’s
Wearhouse 2007 10K). This type of information being disclosed gives analysts or future
investors how the company operates in terms of how the Men’s Wearhouse operates
and how this company is utilizing its expenses and assets to produce profits.
Also, the Men’s Wearhouse allow analysts to understand how they keep track of
their inventory. Because men’s dress attire and apparel are less susceptible to fashion
trends, the Men’s Wearhouse can carry over inventory from previous seasons without
having to markdown the prices of their inventory. The information provided shows
analysts that their inventory impairments will not be as great or as large than in an
industry in which inventory can not carry over from season to season.
Lastly, the Men’s Wearhouse admits to the seasonality of their business. The
Men’s Wearhouse mentions that “a significant portion of our net sales and our net
earnings have been generated in the fourth quarter of each year when holiday season
shopping peaks” (Men’s Wearhouse 2007 10K). The Men’s Wearhouse increases in
their tuxedo rentals during the second quarter due to prom and the increased number
of weddings during that time of year. Although the company acknowledges that their
fourth quarter earnings are in fact larger than any other time of the year, analysts
should still be skeptical of the reporting. However, after analyzing the industry, an
increase in the second and fourth quarter is the norm.
48
In general, the Men’s Wearhouse provides analysts with clear and detailed
explanations in the footnotes and discussion sections of their 10K. When comparing to
past years, the Men’s Wearhouse discloses more information each annual report. This
may be caused by company improvements in its financial reporting or also due to more
regulated accounting practices set forth by FASB. In conclusion, the Men’s Wearhouse
does a well job of disclosing its business activities to analysts.
Quantitative Analysis
When analyzing financial statements of a company, it is just as important to
examine the quantitative information as it is to study the qualitative information. The
quantitative analysis will allow us to study the raw data of Men’s Wearhouse from a
numbers point of view. While the qualitative analysis is more of an opinion, the
quantitative analysis is factual. The firm records numbers and the analyst reports them
as they are written. A qualitative opinion is formed from this quantitative raw data.
The flexibility granted to managers through the Generally Accepted Accounting
Principles (GAAP) allows them the opportunity to distort financials to be more favorable
than reality. Therefore, it is very important for analysts, investors, etc. to be very
careful when examining the numbers of financial statements.
There are two categories of diagnostic ratios that can be used to better
understand the revenues and expenses of a company when analyzing the quantitative
information in financial statements. These two main categories include revenue
manipulation ratios and expense manipulation ratios. These ratios are determinants in
the quality of their financial report disclosure. The following section will provide a cross
sectional and time series analysis among Men’s Wearhouse and their sole competitor,
Jos. A. Bank, by using these diagnostics. All of the information used in the graphs
came from their 10Ks from year 2002-2007.
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Revenue Manipulation Diagnostics
Revenue manipulation diagnostics include a comparison of net sales to the
following: cash collections from sales, net accounts receivable, inventory, and assets. It
is of importance to evaluate the sales performance over several years to determine the
consistency and figure out if there are any discrepancies in the reported numbers. It is
also significant to compare the findings of an individual firm’s sales performance with
that of their competitors in the same industry. This is done to establish whether it is an
industry wide inconsistency or if it only occurs with that specific company.
Sales / Cash Collections from Sales
0.985
0.99
0.995
1
1.005
1.01
1.015
1.02
2003 2004 2005 2006
Men's Wearhouse
Jos. A. Bank
The ratio of net sales to cash collections from sales determines the aptness at
which a company receives cash for sales. It compares sales minus returns (net sales)
to the amount of cash that is actually received in that given year. If a company
provides credit for customers and retains a large value in their accounts receivable,
then their sales to cash from sales ratio would be low. The ultimate goal for firms is to
have a ratio of 1:1. This would mean that stores received cash for sales instantly.
However, this is unrealistic. Most companies have ratios that bounce around the ideal
50
value of one. These days most customers make purchases with major credit cards.
This is favorable for the company because instead of having to pay the company back,
the debt lies with in the credit card company. Therefore, when a customer makes a
purchase with a credit card, the revenue from that transaction goes down in the books
almost at the same rate as it would if they were paying cash. However, if a customer
pays with a credit card from a private company, then the transaction must be recorded
the in accounts receivable. It can not be booked as cash until the credit is paid off to
the private company.
Men’s Wearhouse and their sole competitor, Jos. A. Bank, both appear to have
sales to cash from sales ratios that jump up and down over the past five years.
However, Jos. A. Bank’s ratio has been steadier than that of Men’s Wearhouse. As a
result of high default risk, companies in this specialty retail industry typically do not
provide private credit card. Men’s Wearhouse has chosen to provide this option,
whereas, Jos. A. Bank has not. Men’s Wearhouse offers customers the chance to hold a
private credit card called the Perfect Fit Credit Card. This card is issued by an outside
bank, GE Money Bank. Therefore, when a customer makes a purchase on this privately
labeled credit card, Men’s Wearhouse is not able to record the revenues as cash until
GE Money Bank is paid. This results in greater fluctuations in their ratio.
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Sales / Net Accounts Receivable
0
20
40
60
80
100
120
2003 2004 2005 2006
Men's Wearhouse
Jos. A. Bank
The net sales to net accounts receivable ratio indicates the amount of credit
sales made by a company. It allows for a better understanding of a firm’s sales on
account. The higher the ratio, the higher amount of cash you have already received
from sales. The lower the ratio, the more sales on account a firm has the opportunity of
writing off bad debt expenses from customers that do not pay.
Men’s Wearhouse and Jos. A. Bank both have ratios that have been relatively
around the same range over the past five years. This is favorable because the sales to
accounts receivable ratios should be fairly constant with other firms in an industry. For
the first time in several years, Men’s Wearhouse’s ratio is currently approximately 35
points higher than Jos. A. Bank’s ratio. They have remained lower than Jos. A. Bank for
the majority of the years primarily because they offer a privately labeled credit card.
Therefore, their accounts receivable balance is generally higher than that of their
competitor. However, this past year Men’s Wearhouse has been able to maintain a low
balance in accounts receivable. This is due to an increase in cash sales over the past
four years. This is the opposite of Jos. A. Bank, who has increased sales on account
over the last four years.
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Net Sales / Inventory
00.5
11.5
22.5
33.5
44.5
5
2003 2004 2005 2006
Men's Wearhouse
Jos. A. Bank
The ratio of net sales over inventory will allow a better understanding of a firm’s
ability to generate profit from their inventory. The larger the number of the ratio,
potentially the higher the price they are able to charge for their inventory. This
ultimately increases net sales.
Over the past five years, Men’s Wearhouse has seen a steady increase in their
inventory turnover, despite a constant increase in inventory. This should not typically
happen because as inventory increases, the ratio should decrease. However, Men’s
Wearhouse has continued to improve net sales at a greater rate. Although this is not
ordinary, this outcome does not need to be questioned for overstatement because there
has not been a sudden, dramatic increase; sales have increased at a very steady rate.
Also, Men’s Wearhouse has an advantage because their merchandise can be carried
over season after season and year after year. This helps to avoid stock piling inventory
costs, which allow for greater net sales. On the other hand, Jos. A. Bank has
experienced a highly volatile net sales to inventory ratio over the past five years. In
2004, they increased their inventory by almost 54% and by 38% in 2006, which caused
their ratio to drop, despite an increase in sales all four years. This increase in inventory
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shows an increase in investment and possible growth for the company, while the Men’s
Wearhouse’s steady increase in both sales and inventory shows a more stable firm.
Expense Manipulation Diagnostics
The expense manipulation ratios most useful to the specialty men’s retail
industry consist of the following: the comparison of net sales to assets, a valuation of
the change in cash flow from operations to the operating income and a change in cash
flow from operations to net operating assets. The following section discusses the
relevance and comparison of these ratios among Men’s Wearhouse and Jos. A. Bank.
Asset Turnover
(Net Sales / Assets)
00.5
11.5
22.5
33.5
44.5
5
2003 2004 2005 2006
Men's Wearhouse
Jos. A. Bank
The asset turnover ratio shows how well a firm uses their assets to create sales
revenue. A constant increase in the ratio for the Men’s Wearhouse shows that their
sales are increasing every year. A dramatic increase might indicate that assets are
overstates presenting a red flag, but it has been constant and steady. Jos. A. Bank’s
ratio fluctuates up and down as a result of their huge investment in inventory. This
also causes the amount of assets to increase in years 2004 and 2006, which reduces
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their ratio. When comparing the asset turnover ratio of companies, it is more valuable
when a company maintains a steady ratio, rather than which one has a higher or lower
number. Therefore, Men’s Wearhouse appears to be more valuable in terms of
stability. However, these numbers are to misleading in that they are actually higher.
This is due to the fact that firms in this industry practice operating lease accounting,
allowing for the absence of great amounts of assets on the balance sheet.
Change in Cash Flow from Operations / Operating Income
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2003 2004 2005 2006
Men's WearhouseJos. A. Bank
The ratio of the change in cash flow from operations to operating income refers
to the linkage between the amount of cash generated by operating activities and the
amount of operating income reported on the income statement. It is favorable for
companies to have a low cash flow from operations to operating income ratio. This is
because it represents that more cash inflows from operations than it does from
investing or financing activities. The Men’s Wearhouse keeps this ratio fairly constant.
Jos. A. Bank’s ratio experiences a drastic decrease from year 2004 to 2005. This is due
to a major increase in inventory. The Men’s Wearhouse’s ratio stays very constant,
55
which is preferred because is shows more stability and shows that they did very well at
matching the cash flows from operations to operating income.
Change in Cash Flow from Operations / Net Operating Assets
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
2003 2004 2005 2006
Men's WearhouseJos. A. Bank
This ratio shows how well a company is using long-term operating assets to
produce cash flows from utilizing these assets. These cash flows include operating
activities of fixed assets, property, plant, and equipment. The greater the ratio, the
greater the amount of income produced by those assets. This ratio should be very
steady unless a firm invests in more operating long-term assets in a given year. The
Men’s Wearhouse has a very constant rate which shows they have the long-term assets
needed to generate cash flows from operations. Men’s Wearhouse does not account for
a large portion of their fixed assets, including property and building (operating lease) by
capitalizing them. Instead they expense these assets as rent expense. This results in a
lower change in cash flow from operations to net operating assets ratio. Although Jos.
A. Bank expenses these assets also, they have recently experienced a major decrease.
This is because the made a huge increase in their inventory.
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Potential Red Flags
Unexpected Asset Write-offs
The Men’s Wearhouse steadily increased their long term assets over the last six
years. Accumulated depreciation increased as well, which is expected with the large
increase of plant, property, and equipment. Jos. A. Bank also increased their plant,
property and equipment. This shows us that each of these companies is expanding the
amount of store locations. This does not raise a red flag, because there were not any
sizable asset write-offs.
Unusual Increase in Inventories in Relation to Sales Increases
The Men’s Wearhouse has experienced a constant increase in the sales to
inventory ratio. However, in 2004 and 2006, Jos. A. Bank had a large increase in their
inventory in comparison to sales. This caused their net sales to inventory ratio to fall
during these years. This is largely due to their increase in retail stores. However, this
will raise a red flag when comparing their sales to the industry. Jos. A. Bank’s net sales
to inventory ratio has large fluctuations despite a constant growth rate of sales between
2003 and 2006 because of their unusually large increase in inventory. If we compare
this to the Men’s Wearhouse, we see that their inventory and sales are much more
constant.
Asset Turnover
This ratio is the sales over total assets. However, the declining asset turnover
may not fluctuate as much because all assets are included. So for Jos. A. Bank, their
unusually large increase in inventory will not stick out as much since all assets are
included in the denominator. However, the ratio still decreases in 2004 and 2006 due to
the large increase in inventory.
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Undoing Distortions
After analyzing the financial data and the footnotes to the financial data, we feel
that the Men’s Wearhouse does at great job of disclosing their financial data
transparently. However, analysts should be weary of the large amount of operating
leases as compared to their capital leases. The Men’s Wearhouse explains that over the
next five years, they are committed to over $590,000,00 in operating leases and only
$3,347,000 in capital leases (minus the interest expense).
020000400006000080000
100000120000
Dollar Amount
2007 2009 2011
Year
Comparison of Future Operating vs. Capital Leases (in thousands)
Operating LeasesCapital Leases
To undo this financial distortion, analysts should convert the future values of the
operating lease obligations to present value capital lease commitments. Although
reporting the lease agreements in this manner is in acceptance with GAAP, the Men’s
Wearhouse is able to make their financials look better than they actually are.
58
Year
Operating Leases
(in thousands)
Present Value
Factor
Present Value
(in
thousands)
2007 $113,917 0.8547 $97,365
2008 $105,529 0.7305 $77,089
2009 $92,773 0.6244 $57,927
2010 $76,426 0.5337 $40,789
2011 $57,847 0.4561 $26,384
TOTAL 446492 $299,554
By computing the present value of the operating leases, we are able to derive that the Men’s Wearhouse understated their liabilities and assets by $146,938,000.
Asset Turnover Ratio
The understated amount of assets will decrease the asset turnover ratio. The
Men’s Wearhouse has an asset turnover ratio of 1.75 based on their accounting policies.
However, with an adjusted asset balance, a more accurate asset turnover ratio is 1.55.
This decrease is not very drastic, just a .20 decrease. However, it does depict a more
accurate representation of the Men’s Wearhouse’s ability to generate sales with their
assets.
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Conclusion
Overall, the Men’s Wearhouse displays their financial statements in a reasonably
transparent manner allowing analysts to get a “true and fair” picture of a firm’s financial
operating position and performance. Analyst will need to adjust the financial statements
for the capitalization of operating leases. The Men’s Wearhouse understated their
liabilities by $146,938,000, which increases their assets and increase their interest
expense. This increase in interest expenses lowers their net income. However there is
also a reduction in rent expense which reduces operating expenses. This change results
in net income going back up.
Financial Ratio Analysis, Forecast Financials,
& Cost of Capital Estimation
Analysts use a series of ratios in an effort to measure the financial performance
of a company in comparison to their main competitors in the industry. The most
beneficial ratios that analysts use are called the Basic 14 and consist of the following:
liquidity ratios, leverage ratios, and capital structure ratios. We have constructed a
trend analysis along with a cross sectional analysis. These analyses are important
because they are a benchmark for comparing firms in an industry. We will valuate
liquidity, profitability, and capital structure ratios in order to complete these analyses.
With the use of these ratios, we are able to forecast future financials. We
forecast future financials by studying historical data. The historical data we examine is
from past income statements, balance sheets, and statement of cash flows. We will
create common size financials for each of these statements.
The estimation of the cost of capital is a very important step. First, we use the
Capital Asset Pricing Model or the backdoor method to estimate the cost of equity.
Then, we estimate the weighted average cost of debt by using stated interest rates
60
from Men’s Wearhouse’s 10K. Finally, we value an estimate of the before and after tax
Weighted Average Cost of Capital. We were able to do this by incorporating our
previously estimated cost of equity and cost of debt.
Liquidity Ratio Analysis
Liquidity refers to a firms ability to pay off their debts immediately using assets
that are easily converted to cash or cash equivalents. Liquidity ratios show how well the
firm is able to provide adequate near-cash assets to cover their obligations in a suitable
manner. They illustrate how conveniently a firm meets their short-term financial
obligations.
Current Ratio
The current ratio measures the relationship between a company’s current assets
and current liabilities. Current assets consist of the following: cash, cash equivalents,
marketable securities, receivables, and inventory. Current Liabilities include payables
and short-term debt. The primary purpose this ratio serves is to show how quickly a
firm would be able to pay off short-term debt when needed. The greater the ratio, the
61
better chance a company has to pay off what they are liable for. Over the last five
years, the Men’s Wearhouse’s current ratio declined over the course of three years, but
has risen up to its original value in 2002. Therefore, the 3.06 current ratio is viewed as
an unfavorable impact on liquidity. In comparison, Jos A. Bank maintains a current
ratio that has seen an overall increase over the past five years. Men’s Wearhouse has a
higher current ratio but is somewhat stagnant to Jos A. Banks.
Quick Asset Ratio
The quick asset ratio, also known as the acid-test, is the relationship between
the sum of cash, marketable securities, and accounts receivable and the total of current
liabilities. This ratio is very similar to the current ratio; the only difference is the quick
ratio leaves out inventory. Inventory can be very challenging to convert to cash.
Therefore, the quick ratio is a much more conventional way of measuring how quickly a
company is able to pay off short-term debt. It provides much more clarity when
determining how liquid a company really is. The Men’s Wearhouse quick asset ratio has
increased over the past five years, despite a slight drop in the last year. Jos A. Banks
quick ratio remained relatively constant with a slight improvement in the most recent
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year. In comparison, Men’s Wearhouse’s quick asset ratio of .87 is much higher than
Jos A. Banks of .42. This is the closet their ratios have been in the past five years.
Receivables Turnover
The receivables turnover portrays the relationship amongst the net sales and
accounts receivable of a firm. The efficiency of how a company’s assets are used is
measured through this percentage. When the receivables turnover ratio is low, it
represents a delay on the collection of accounts receivable. Men’s Wearhouse has
experienced a dramatic incline in their receivables turnover over the past five years.
This is due to their ability to quickly collect accounts receivables.
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Days Sales Outstanding
The days sales outstanding represents the days supply of receivables. Thus, this
ratio is simply the number of days in one year divided by the receivables turnover. The
days sales outstanding ratio assesses precisely the amount of time it takes a company
to collect on their accounts receivable. In 2002 the Men’s Wearhouse did not file any
accounts receivable in their 10K. This is why their days sales outstanding is zero. From
2003 to 2006, their days sales outstanding has steadily decreased. Therefore, Men’s
Wearhouse days sales outstanding has seen a positive impact. The Jos A. Bank’s days
sales outstanding has had a slight increase over the last five years, which is a negative
outcome.
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Inventory Turnover
The inventory turnover ratio measures the percentage of the cost of goods sold
to the total inventory. It measures a company’s capacity to move inventory; either by
selling it or replacing it. Depending on how quickly a firm is able to turn over their
inventory, they may be considered efficient or not. A low inventory turnover represents
reduced sales or too much inventory. On the other hand, a high inventory turnover
implies high sales or too little inventory. The Men’s Wearhouse has a constant
inventory turnover which indicates a well managed inventory system and a stable firm.
It takes about 2.5 months for the Men’s Wearhouse to turn over their inventory.
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Days Supply of Inventory
The days supply of inventory illustrates the timeliness of idle inventory. In order
to calculate the days supply of inventory, the number of days in one year, which is 365,
is divided by inventory turnover. Men’s Wearhouse turns their inventory every 153
days; almost once every six months. Along with days sales outstanding, it is a
component of the cash-to-cash cycle.
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Cash to Cash Cycle
With a Days Sales Outstanding of 5.3 and a Days Supply of inventory of about
153.5, Mens Wearhouse’s cash-to-cash cycle is approximately 156.8 days. It is a sum of
the days taken for inventory turnover and also the days taken to collect sales on
account. Men’s Wearhouse’s cash-to-cash cycle is much more frequent than that of
Jos. A. Bank’s. Jos. A. Banks only turns their inventory close to once a year.
Seasonality does not really affect the cash-to-cash cycle in this industry.
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Working Capital Turnover
Working capital turnover represents the link between sales and working capital.
Working capital is the difference between total current assets and total current
liabilities. This turnover measures how effectively a company is able to convert working
capital into sales. If a company is striving to raise working capital, they must increase
either sales or assets. In the case of Men’s Wearhouse, they experience a negative
impact on their working capital turnover. Their turnover has been very versatile over
the past five years. On the other hand, Jos. A. Bank has experienced a constant
working capital turnover for the past five years, with a decline only in the most recent
year.
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Days Working Capital
Days Working Capital measures the number of days it takes to turn working
capital into sales. A higher number of working capital is generally preferred which
translates that a lower number of days working capital is preferred. A lower days
working capital shows the company is quickly and efficiently turning their working
capital right into profit, or sales. You can calculate days working capital simply by
dividing the number of days in a year by working capital turnover. Mens Wearhouse’s
days working capital is 88.18. This number is so high because our inventory is causing
our current assets to be considerably higher than our current liabilities. It is
considerably higher than Jos A Banks because the have a higher working capital
turnover. We estimate their days working capital to be approximately 65.18.
Conclusion
Overall, the majority of Men’s Wearhouse’s liquidity ratios turn out to have
favorable impacts. This shows that in the event of short-term debt obligations, Men’s
Wearhouse would be able to provide the necessary liquidation. Over all, the Men’s
Wearhouse outperforms Jos. A. Bank from a liquidity analysis standpoint.
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Profitability Analysis
The objective of a profitability analysis is to determine how efficiently a firm can
turn a profit, in comparison to their industry. There are four important factors that
relate to profits. They are the following: operating efficiency, asset productivity,
profitability from assets, and profitability on investments. By creating a common size
income statement, we are able to examine every part as a percentage of sales.
Operating efficiency is measured using the following ratios: gross profit margin,
operating expense ratio, and net profit margin. Asset productivity is measured with the
asset turnover ratio. Profitability from assets is constructed by calculating the rate of
return on assets. Finally, the profitability on investments is measured by calculating the
rate of return on equity.
Gross Profit Margin
The gross profit margin is calculated to show the relationship of gross profit as a
percentage of sales. The gross profit is the difference between a firm’s revenues and
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cost of goods sold. Thus, the margin is a percentage of this in relation to revenues.
When a company obtains a high gross profit margin it indicates the ability for that firm
to ask relatively high prices for their product. It may also indicate that the company is
proficient in minimizing costs. Men’s Wearhouse has a favorable gross profit margin of
43.34. This outcome is considered high. A high gross profit margin is favorable
because the higher it is, the more money they have left over after paying costs. This
money left over is available for them to use for other purposes. A good example would
be for a firm to pursue growth by reinvesting this money. Both Men’s Wearhouse and
Jos. A. Bank have seen a gradual incline in their gross profit margin over the past five
years. However, Jos. A. Bank’s margin of just over 60 is almost 20 percent higher than
Men’s Wearhouse of 43.34.
Operating Expense Ratio
The operating expense ratio evaluates a firm’s operating efficiency. Specifically
the ratio is selling and administrative expenses as a percent of sales. Both firms have
very constant operating expense ratios. The lower the ratio the better, because it
means that selling and administrative expenses are a smaller percentage of sales. In
this case, the Men’s Wearhouse’s ratio is about 20% smaller than Jos. A. Bank.
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Net Profit Margin
The net profit margin measures net income as a percentage of total revenues.
This ratio is not very useful in portraying the performance of an individual firm.
Instead, its importance lies in the fact that it conveys how well a company competes on
price in comparison to other firms in their industry. The operating efficiency of a
company is evidenced through this ratio. The net profit margin for Men’s Wearhouse is
determined to be favorable. Men’s Wearhouse and Jos. A. Bank currently obtain
approximately the same net profit margin. They have both experienced an increase
over the past five years; Men’s Wearhouse being slightly steeper. This shows that
Men’s Wearhouse and Jos. A. Banks are competing relatively in the same price range.
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Asset Turnover
The asset turnover shows the relationship between the overall sales and total
assets of a company. Asset productivity is measured by using this ratio. It is important
to evaluate profitability by using this ratio because it shows revenue productivity of total
resources as well (mmoore.ba.ttu.edu). A high asset turnover represents a proficient
use of assets. Men’s Wearhouse has a slight downward sloping asset turnover over the
last five years. This signifies a small decline in the use of assets to generate sales over
the past five years.
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Return on Assets
Profitability from assets is determined by calculating the rate of return on assets.
This ratio shows the effect on net income as the result of an increase of one dollar in
total assets. Therefore, the rate of return on assets is calculated as net income divided
by total assets. In other words, it is the product of the profit margin and the asset
turnover. Either the profit margin or the asset turnover is high, not both. Over the last
five years the Men’s Wearhouse has enjoyed an upward sloping return on assets which
indicates that their assets are generating a higher net income.
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Return on Equity
Profitability on investments is established by calculating the rate of return on
equity. In other words, this ratio “measures the profitability of the owners’ interest in
total assets” (mmoore.ba.ttu.edu). When the return on equity ratio is high, it means
that owners’ equity is making the firm more profitable. The owners’ equity of the Men’s
Wearhouse has been improving the profitability of the firm over the past five years.
However, Jos. A. Bank’s return on equity is much higher than the Men’s Wearhouse. But
over the last five years the gap has closed between the two firms.
Conclusion
Men’s Wearhouse is very proficient in turning a profit. Operating efficiency,
asset productivity, profitability from assets, and profitability on investments are all
achieved. Men’s Wearhouse is in line with the industry standard. As seen by this
analysis, Men’s Wearhouse is improving profitability with time.
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Capital Structure Analysis
The capital structure of a company is how a company finances assets that they
have acquired. We used two ratios to evaluate the Men’s Wearhouse; debt to equity
ratio and times interest earned. By understanding how a company acquires assets, we
can determine the current financial strength of the Men’s Wearhouse.
Debt to Equity Ratio
The debt to equity ratio shows the portion of total debt relative to the firm’s
equity. This is an important ratio because it indicates a company’s credit risk. Credit risk
is the risk that a firm’s cash flows will be able to cover the interests and debt repayment
they owe. The Men’s Wearhouse debt to equity ratio is less than one, which means that
more of their assets are financed by equity. This is a positive sign because it means
their credit risk is lower. Jos. A. Bank on the other hand had a ratio well above one
from 2002 to 2005, but has fallen below one in the last two years.
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Times Interest Earned
The times interest earned ratio indicates a firm’s ability to cover their interest
expense with their income from operations. The Men’s Wearhouse income from
operations must be able to cover their interest expense before the stock-holders can
make money. Over the last five years the times interest earned ratio has remained
relatively flat when compared to their competitor Jos. A. Bank. Their large steady
increase is a positive ratio indicating company growth due to increased income from
operations. The Men’s Wearhouse steady ratio shows stability in the industry.
Conclusion
The Men’s Wearhouse has a solid capital structure. It has a much lower credit
risk than Jos. A. Bank due to their lower debt to equity ratio. Although Jos. A. Bank has
a higher times interest earned, the Men’s Wearhouse has enjoyed a constant times
interest earned ratio over the last five years which shows stability.
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Financial Ratio Analysis
LIQUIDITY 2002 2003 2004 2005 2006 Impact
Current Ratio 3.02 3.02 2.68 2.63 3.06 -
Quick Asset Ratio 0.26 0.62 0.70 0.78 1.18 +
A/R Turnover 0.00 69.62 86.32 82.75 111.78 +
A/R Days 0.00 5.24 4.23 4.41 3.27 +
Inventory Turnover 2.24 2.44 2.43 2.53 2.38 0
Inventory Days 162.99 149.51 150.44 144.27 153.54 +
Working Capital Turnover 4.29 4.28 4.33 4.44 3.83 -
Days working captial 85.10 85.25 84.26 82.15 95.32 -
Cash to Cash 162.99 154.76 154.67 148.68 156.81 +
PROFITABILITY
Gross Profit Margin 35.08% 36.87% 38.99% 40.42% 43.34% +
Operating Expense Ratio 29.72% 31.00% 31.35% 30.83% 31.44% 0
Net Profit Margin 3.27% 3.57% 4.61% 6.02% 7.89% +
Asset Turnover 1.80 1.81 1.76 1.74 1.68 -
Return on Assets 5.94% 6.93% 9.28% 11.83% 14.96% +
Return on Equity 8.56% 9.75% 13.42% 21.30% 26.12% +
CAPITAL STRUCTURE
Debt to equity ratio 0.41 0.45 0.80 0.75 0.79 -
Times interest earned 30.91 20.42 20.02 28.07 24.30 -
IGR 5.90% 6.46% 8.13% 10.46% 14.19%
SGR 8.54% 11.64% 14.19% 18.72% 20.65%
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Financial Ratio Analysis (revised)
Liquidity 2002 2003 2004 2005 2006 Impact
Current Ratio 2.92 2.68 2.63 3.06 3.01 -
Quick Asset Ratio 0.62 0.70 0.78 1.18 0.87 +
Receivables Turnover 64.74 77.72 74.20 102.45 110.59 +
Days Sales Outstanding 5.64 4.70 4.92 3.56 3.30 +
Inventory Turnover 2.33 2.26 2.32 2.47 2.38 0
Days Supply of Inventory 156.35 161.47 157.12 147.95 153.54 +
Working Capital Turnover 3.98 3.90 3.98 3.51 4.14 -
Days Working Captial 91.68 93.58 91.62 104.01 88.18 -
Cash to Cash Cycle 161.98 166.17 162.04 151.52 156.85 +
Profitability
Gross Profit Margin 35.08% 36.87% 38.99% 40.42% 43.34% +
Operating Expense Ratio 29.72% 31.00% 31.35% 30.83% 31.44% 0
Net Profit Margin 3.27% 3.57% 4.61% 6.02% 7.89% +
Asset Turnover 2.62 2.44 2.47 2.36 2.76 -
Return on Assets 4.90% 5.43% 6.96% 9.11% 11.70% +
Return on Equity 8.31% 9.35% 14.63% 18.27% 23.68% +
Capital Structure
Debt to Equity Ratio 0.72 1.10 1.00 1.02 0.65 -
Times Interest Earned 30.91 20.42 20.02 28.07 24.30 -
In regard to liquidity and profitability analysis, Men’s Wearhouse experiences a
majority of favorable impacts. However, the capital structure of Men’s Wearhouse sees
an unfavorable in both the debt to equity and times interest earned ratios. The Internal
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Growth Rate and Sustainable Growth Rate both improve each year over the past five
years.
Internal Growth Rate
The internal growth rate (IGR) measures how much a firm is growing based on
their own dollar. The IGR shows how a company is increasing their assets through their
retained earnings from the balance sheet. This ratio is significant because it shows
growth without the aid of outside funding such as debt from lending. IGR is calculated
by the product of the Men’s Wearhouse’s return on assets and one minus the dividend
payment.
Year 2002 2003 2004 2005 2006
IGR 5.9% 6.46% 8.13% 10.46% 14.19%
The Men’s Wearhouse’s IGR constantly increased over the past five years. This
explains that the Men’s Wearhouse has been able to add assets with their own funding.
This is a favorable characteristic of a company and shows financial strength.
Sustainable Growth Rate
The sustainable growth rate (SGR) is the potential growth rate a company can
reach without added additional debt. When a firm surpasses this rate supplementary
funding is needed to finance the growth. This is achieved by increasing debt. The SGR
is calculated by multiplying the IGR and one plus dividends over equity. Generally, the
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SGR and IGR move together because the IGR is the most significant variable for the
SGR.
Year 2002 2003 2004 2005 2006
SGR 8.54% 11.64% 14.19% 18.72% 20.65%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2002 2003 2004 2005 2006
IGRSGR
Forecasted Financials
After analyzing and scrutinizing the Men’s Wearhouse financial statements, we
disclose the methods and techniques used to help forecast their future financials.
Currently, we have forecasted the Income Statement, Balance Sheet, and Statement of
Cash Flows to better help us to predict the future performance of the company. We
forecasted the financials based on the last six financial statements reported to the SEC
and extended the forecast for the next ten years beginning with 2008 and ending in
2017. The financials from the 10-K’s from years 2003-2007 were used in ratios to
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develop trends regarding the future of the company’s performance. Similar information
has been gathered on the Men’s Wearhouse’s main competitor to be able to compare
their performances to each other. Although the Men’s Wearhouse has many other
competitors such as Dillard’s, Brooks Brothers, or Burlington Coat Factory; Jos. A. Bank
is the only competitor which discloses information from their operations publicly and the
information disclosed derives from the actual sales of men’s formal wear and suits.
Dillard’s financials are based on the department store as a whole, Brooks Brothers is a
privately owned company and do not report their financials to the SEC, and the
Burlington Coat Factory sells many more types of clothing than just men’s formal wear.
We have also used the Men’s Wearhouse 10-Q’s to verify and adjust our assumptions
for our expected future forecasts. Our assumptions are very much in-line with analysts
from Yahoo! Finance, and both our forecasts and the analysts input confer that the
Men’s Wearhouse will be a prospering firm for the next coming years.
Income Statements
Mens Wearhouse Consolidated Income Statements
Income Statement(Dollars and shares in thousands, except 2002 2003 2004 2005 2006 Average Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016per share and per square foot data)
Net sales $1,295,049 $1,392,680 $1,546,679 $1,724,898 $1,882,064 9.5000% $2,060,860 $2,256,642 $2,471,023 $2,705,770 $2,962,818 $3,244,286 $3,552,493 $3,889,980 $4,259,528 $4,664,183Cost of Goods Sold $840,810 $879,234 $943,675 $1,027,763 $1,066,359 59.0000% $1,215,907 $1,331,419 $1,457,903 $1,596,404 $1,748,063 $1,914,129 $2,095,971 $2,295,088 $2,513,121 $2,751,868Gross margin $454,239 $513,446 $603,004 $697,135 $815,705 41.0000% $844,953 $925,223 $1,013,119 $1,109,366 $1,214,755 $1,330,157 $1,456,522 $1,594,892 $1,746,406 $1,912,315Selling, Administrative, and General Expenses $384,939 $431,663 $484,916 $531,839 $591,767 30.0000% $618,258 $676,993 $741,307 $811,731 $888,845 $973,286 $1,065,748 $1,166,994 $1,277,858 $1,399,255Operating income $69,300 $81,783 $118,088 $165,296 $223,938 11.0000% $226,695 $248,231 $271,813 $297,635 $325,910 $356,871 $390,774 $427,898 $468,548 $513,060Interest Income $981 $1,495 $1,526 $3,280 $9,786 0.2000% $4,122 $4,513 $4,942 $5,412 $5,926 $6,489 $7,105 $7,780 $8,519 $9,328Interest Expense $2,242 $4,006 $5,899 $5,888 $9,216 0.3000% $6,183 $3,994 $4,374 $4,789 $5,244 $5,742 $6,288 $6,885 $7,539 $8,256Earnings Before Income Taxes $68,039 $79,272 $113,715 $162,688 $224,508 10.5000% $216,390 $236,947 $259,457 $284,106 $311,096 $340,650 $373,012 $408,448 $447,250 $489,739Provisions for Income Taxes $25,684 $29,538 $42,359 $58,785 $75,933 3.5000% 72,130 78,982 86,486 94,702 103,699 113,550 124,337 136,149 149,083 163,246Net earnings $42,355 $49,734 $71,356 $103,903 $148,575 7.0000% 144,260 157,965 172,972 189,404 207,397 227,100 248,675 272,299 298,167 326,493
Common Size Income Statement2002 2003 2004 2005 2006 Average Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Sales Growth Percent 7.54% 11.06% 11.52% 9.11% 9.81% 9.50000% 9.50% 9.50% 9.50% 9.50% 9.50% 9.50% 9.50% 9.50% 9.50% 9.50%Net Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00000% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%Cost of Goods Sold 64.92% 63.13% 61.01% 59.58% 56.66% 61.06% 59.00000% 59% 59% 59% 59% 59% 59% 59% 59% 59% 59%Gross Profit 35.08% 36.87% 38.99% 40.42% 43.34% 38.94% 41.00000% 41% 41% 41% 41% 41% 41% 41% 41% 41% 41%Selling, Administrative and General Expenses 29.72% 31.00% 31.35% 30.83% 31.44% 30.87% 30.00000% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00%Operating Income 5.35% 6.32% 8.48% 10.69% 12.98% 8.76% 11.00000% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00%Interest Income 0.08% 0.11% 0.10% 0.19% 0.52% 0.20% 0.20000% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2%Interest Expense 0.17% 0.29% 0.38% 0.34% 0.49% 0.33% 0.30000% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3%Earnings Before Income Taxes 5.25% 5.69% 7.35% 9.43% 11.93% 7.93% 10.90000% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%Provisions for Income Taxes 1.98% 2.12% 2.74% 3.41% 4.03% 2.86% 3.50000% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4%Net earnings 3.27% 3.57% 4.61% 6.02% 7.89% 5.07% 7.00000% 7% 7% 7% 7% 7% 7% 7% 7% 7% 7%
Actual Financial Statements Forecast Financials
Actual Financial Statements Forecast Financials
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Income Statement (revised)(Dollars and shares in thousands 2002 2003 2004 2005 2006 Average Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016per share and per square foot dat
Net sales $1,295,049 $1,392,680 $1,546,679 $1,724,898 $1,882,064 9.5000% $2,060,860 $2,256,642 $2,471,023 $2,705,770 $2,962,818 $3,244,286 $3,552,493 $3,889,980 $4,259,528 $4,664,183Cost of Goods Sold $840,810 $879,234 $943,675 $1,027,763 $1,066,359 59.0000% $1,215,907 $1,331,419 $1,457,903 $1,596,404 $1,748,063 $1,914,129 $2,095,971 $2,295,088 $2,513,121 $2,751,868Gross margin $454,239 $513,446 $603,004 $697,135 $815,705 41.0000% $844,953 $925,223 $1,013,119 $1,109,366 $1,214,755 $1,330,157 $1,456,522 $1,594,892 $1,746,406 $1,912,315Selling, Administrative, and General Expenses $384,939 $431,663 $484,916 $531,839 $591,767 30.0000% $618,258 $676,993 $741,307 $811,731 $888,845 $973,286 $1,065,748 $1,166,994 $1,277,858 $1,399,255Operating income $69,300 $81,783 $118,088 $165,296 $223,938 11.0000% $226,695 $248,231 $271,813 $297,635 $325,910 $356,871 $390,774 $427,898 $468,548 $513,060Interest Income $981 $1,495 $1,526 $3,280 $9,786 0.2000% $4,122 $4,513 $4,942 $5,412 $5,926 $6,489 $7,105 $7,780 $8,519 $9,328Interest Expense $2,242 $4,006 $5,899 $5,888 $9,216 0.3000% $13,809 $14,396 $15,039 $15,743 $16,515 $17,359 $18,284 $19,296 $20,405 $21,619Earnings Before Income Taxes $68,039 $79,272 $113,715 $162,688 $224,508 10.5000% $217,008 $238,348 $261,715 $287,303 $315,321 $346,001 $379,596 $416,382 $456,662 $500,770Provisions for Income Taxes $25,684 $29,538 $42,359 $58,785 $75,933 3.5000% 72,130 78,982 86,486 94,702 103,699 113,550 124,337 136,149 149,083 163,246Net earnings $42,355 $49,734 $71,356 $103,903 $148,575 7.0000% 144,878 159,365 175,230 192,601 211,622 232,451 255,258 280,232 307,579 337,523
Actual Financial Statements Forecast Financials
In making our forecasts for the income statement, we analyzed the trends we
had noticed from years 2003-2007. The foundation of the entire income statement is
based on the fact that we believe the Men’s Wearhouse sales will continue to grow at
9.5% per year. This assumption is made by comparing past financial statements to the
most recent filing and comparing our estimated numbers with numbers estimated by
analysts from Yahoo! Finance. Analysts from Yahoo! Finance believe that the firm will
grow 14% next year. As we have been trying to forecast out growth for 10 years, we
feel that a 14% growth rate over 10 years would be considered much larger than what
any manager of a firm would expect each successive year. Our predicted 9.5% growth
rate in sales also aligns closer to the expected industry growth rate in the coming years
than a 14% growth rate. We have also assumed that gross profit and net earnings to
be 41% and 7% of sales. However, our most recent 10-Q’s shows gross profit to be
closer to 46% of sales and net earnings to be around 8% of sales. These 10-Q’s are
based off of the recurring facts that the Men’s Wearhouse business increases during the
Spring and Summer months due to prom season and the increase number of weddings
during those months. In a similar fashion, the average increase in sales from year to
year averaged out over the past six years proves to be in the area of 9.5% and this is
the main reason why we chose to forecast yearly growth from this rate.
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Balance Sheets
Men's Wearhouse Balance Sheets (In thousands, except shares)
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016AssetsCURRENT ASSETSCash and Cash Equivalents $38,644 $84,924 $132,146 $165,088 $200,226 $179,684Short-term Investments $0 $0 $0 $0 $62,775 $0Accounts Receivable, net $0 $20,004 $17,919 $20,844 $16,837 $17,018 $20,609 $22,566 $24,710 $27,058 $29,628 $32,443 $35,525 $38,900 $42,595 $46,642Inventories $375,471 $360,159 $388,956 $406,225 $416,603 $448,586 $517,407 $566,561 $620,384 $679,321 $743,856 $814,523 $891,902 $976,633 $1,069,413 $1,171,008Other Current Assets $37,220 $29,495 $31,028 $34,920 $33,171 $35,531 Total Current Assets $451,335 $494,582 $570,049 $626,997 $729,612 $680,829 $824,344 $902,657 $988,409 $1,082,308 $1,185,127 $1,297,714 $1,420,997 $1,555,992 $1,703,811 $1,865,673
PROPERTY AND EQUIP., AT COSTLand $5,778 $6,005 $6,205 $8,878 $9,122 $9,093Buildings $23,199 $23,729 $29,739 $50,511 $54,515 $63,477Leasehold Improvements $154,398 $162,734 $196,490 $219,250 $244,300 $264,276Furniture, Fixtures, and Equipment $203,154 $213,391 $241,742 $275,822 $304,020 $332,494 Total Property and Equip. $386,529 $405,859 $474,176 $554,461 $611,957 $669,340Less accumulated depr. And amort. -$175,475 -$195,679 -$250,353 -$294,393 -$342,371 -$379,700 Net Property and Equipment $211,054 $210,180 $223,823 $260,068 $269,586 $289,640TUXEDO RENTAL PRODUCT, net $52,561 $57,565GOODWILL $36,607 $43,867 $55,824 $57,601 $5,687OTHER ASSETS, net $55,480 $27,994 $40,388 $50,433 $13,914 $12,051Total Non-Current Assets $266,534 $274,731 $308,078 $366,325 $393,662 $416,123 $353,290 $386,853 $423,604 $463,846 $507,912 $556,163 $608,999 $666,854 $730,205 $799,574 TOTAL $717,869 $769,313 $878,127 $993,322 $1,123,274 $1,096,952 $1,177,634 $1,289,510 $1,412,013 $1,546,154 $1,693,039 $1,853,878 $2,029,996 $2,222,846 $2,434,016 $2,665,247
LIABILITIES AND SHAREHOLDERS' EQUITYCURRENT LIABILITIESAccounts Payable $87,381 $98,716 $115,828 $132,212 $125,064 $111,213Accrued Expenses $44,033 $55,323 $71,132 $82,923 $91,935 $95,249 $100,099 $109,608 $120,021 $131,423 $143,908 $157,580 $172,550 $188,942 $206,891 $226,546Current Portion of Long-Term Debt $2,359 $2,037Income Taxes Payable $15,627 $13,234 $26,044 $23,633 $21,086 $19,676 Total Current Liabilities $149,400 $169,310 $213,004 $238,768 $238,085 $226,138 $251,908 $278,574 $308,020 $340,533 $376,428 $416,053 $459,792 $508,066 $561,341 $620,130LONG-TERM DEBT $37,740 $38,709 $131,000 $130,000 $205,251 $72,967DEFERRED TAXES AND OTHER LIABILITIES $20,846 $29,533 $46,331 $55,706 $52,405 $44,075 Total Liabilities $207,986 $237,552 $390,335 $424,474 $495,741 $343,180 $355,797 $393,460 $435,050 $480,972 $531,670 $587,637 $649,414 $717,597 $792,844 $875,878
COMMITMENTS AND CONTINGENCIESSHAREHOLDERS' EQUITYPreferred Stock, $.01 par value, 2,000,000 shares authorized $0 $0 $0 $0 $0 $0Common Sock, $.01 par value, 100,000,000 shares authorized, $424 $426 $431 $436 $671 $691Capital in excess of par $191,888 $196,146 $205,636 $218,327 $255,214 $286,120Retained earnings $355,128 $397,540 $442,074 $513,430 $614,680 $752,361 $912,758 $1,089,550 $1,284,037 $1,497,647 $1,731,939 $1,988,624 $2,269,573 $2,576,835 $2,912,655 $3,279,491Accumulated other comprehensive income -$3,198 $66 $10,357 $17,477 $26,878 $23,496 Total Equity before T-Stock $544,242 $594,178 $658,498 $749,670 $897,443 $1,062,668Treasury Stock, 14,169,241 and 15,234,677 shares at -$34,359 -$62,417 -$170,706 -$180,822 -$269,910 -$308,896Total Shareholders' Equity $509,883 $531,761 $487,792 $568,848 $627,533 $753,772 $821,838 $896,050 $976,963 $1,065,183 $1,161,369 $1,266,240 $1,380,582 $1,505,248 $1,641,172 $1,789,370 TOTAL LIABILITIES AND SHAREHOLDER'S E $717,869 $769,313 $878,127 $993,322 $1,123,274 $1,096,952 $1,177,634 $1,289,510 $1,412,013 $1,546,154 $1,693,039 $1,853,878 $2,029,996 $2,222,846 $2,434,016 $2,665,247
Forecast FinancialsActual Financials
84
Men's Wearhouse Balance Sheets (In thousands, except shares) (revised)
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016AssetsCURRENT ASSETSCash and Cash Equivalents $38,644 $84,924 $132,146 $165,088 $200,226 $179,684Short-term Investments $0 $0 $0 $0 $62,775 $0Accounts Receivable, net $0 $20,004 $17,919 $20,844 $16,837 $17,018 $20,609 $22,566 $24,710 $27,058 $29,628 $32,443 $35,525 $38,900 $42,595 $46,642Inventories $375,471 $360,159 $388,956 $406,225 $416,603 $448,586 $686,953 $752,214 $823,674 $901,923 $987,606 $1,081,429 $1,184,164 $1,296,660 $1,419,843 $1,554,728Other Current Assets $37,220 $29,495 $31,028 $34,920 $33,171 $35,531 Total Current Assets $451,335 $494,582 $570,049 $626,997 $729,612 $680,829 $556,989 $609,903 $667,844 $731,289 $800,762 $876,834 $960,133 $1,051,346 $1,151,224 $1,260,590
PROPERTY AND EQUIP., AT COSTLand $5,778 $6,005 $6,205 $8,878 $9,122 $9,093Buildings $170,137 $170,667 $176,677 $197,449 $201,453 $210,415Leasehold Improvements $154,398 $162,734 $196,490 $219,250 $244,300 $264,276Furniture, Fixtures, and Equipm $203,154 $213,391 $241,742 $275,822 $304,020 $332,494 Total Property and Equip. $533,467 $552,797 $621,114 $701,399 $758,895 $816,278Less accumulated depr. And am -$175,475 -$195,679 -$250,353 -$294,393 -$342,371 -$379,700 Net Property and Equipment $357,992 $357,118 $370,761 $407,006 $416,524 $436,578TUXEDO RENTAL PRODUCT, net $52,561 $57,565GOODWILL $36,607 $43,867 $55,824 $57,601 $5,687OTHER ASSETS, net $55,480 $27,994 $40,388 $50,433 $13,914 $12,051Total Non-Current Assets $413,472 $421,669 $455,016 $513,263 $540,600 $563,061 $816,918 $894,525 $979,505 $1,072,557 $1,174,450 $1,286,023 $1,408,195 $1,541,974 $1,688,461 $1,848,865 TOTAL $864,807 $916,251 $1,025,065 $1,140,260 $1,270,212 $1,243,890 $1,373,907 $1,504,428 $1,647,349 $1,803,847 $1,975,212 $2,162,857 $2,368,329 $2,593,320 $2,839,685 $3,109,455
LIABILITIES AND SHAREHOLDERS' EQUITYCURRENT LIABILITIESAccounts Payable $87,381 $98,716 $115,828 $132,212 $125,064 $111,213Accrued Expenses $44,033 $55,323 $71,132 $82,923 $91,935 $95,249 $116,782 $127,876 $140,025 $153,327 $167,893 $183,843 $201,308 $220,432 $241,373 $264,304Current Portion of Long-Term D $2,359 $2,037Income Taxes Payable $15,627 $13,234 $26,044 $23,633 $21,086 $19,676 Total Current Liabilities $149,400 $169,310 $213,004 $238,768 $238,085 $226,138 $390,870 $430,738 $474,640 $522,982 $576,209 $634,814 $699,335 $770,366 $848,559 $934,634LONG-TERM DEBT $184,678 $185,647 $277,938 $276,938 $352,189 $219,905DEFERRED TAXES AND OTH $20,846 $29,533 $46,331 $55,706 $52,405 $44,075 Total Liabilities $354,924 $384,490 $537,273 $571,412 $642,679 $490,118 $552,069 $608,378 $670,386 $738,664 $813,843 $896,617 $987,747 $1,088,072 $1,198,513 $1,320,085
COMMITMENTS AND CONTINGENCIESSHAREHOLDERS' EQUITYPreferred Stock, $.01 par value, 2,000,000 shares authorized $0 $0 $0 $0 $0 $0Common Sock, $.01 par value, 100,000,000 shares authorize $424 $426 $431 $436 $671 $691Capital in excess of par $191,888 $196,146 $205,636 $218,327 $255,214 $286,120Retained earnings $355,128 $397,540 $442,074 $513,430 $614,680 $752,361 $912,758 $1,089,550 $1,284,037 $1,497,647 $1,731,939 $1,988,624 $2,269,573 $2,576,835 $2,912,655 $3,279,491Accumulated other comprehens -$3,198 $66 $10,357 $17,477 $26,878 $23,496 Total Equity before T-Stock $544,242 $594,178 $658,498 $749,670 $897,443 $1,062,668Treasury Stock, 14,169,241 and -$34,359 -$62,417 -$170,706 -$180,822 -$269,910 -$308,896Total Shareholders' Equity $509,883 $531,761 $487,792 $568,848 $627,533 $753,772 $821,838 $896,050 $976,963 $1,065,183 $1,161,369 $1,266,240 $1,380,582 $1,505,248 $1,641,172 $1,789,370 TOTAL LIABILITIES AND $864,807 $916,251 $1,025,065 $1,140,260 $1,270,212 $1,243,890 $1,373,907 $1,504,428 $1,647,349 $1,803,847 $1,975,212 $2,162,857 $2,368,329 $2,593,320 $2,839,685 $3,109,455
Actual Financials Forecast Financials
When analyzing the Men’s Wearhouse balance sheets, we discovered an increasing
trend in total assets and an increasing trend in total liabilities and equity. After examining the
differences from the last six years, we can see that there is a steady increase of 9.03% per year
in these numbers. After establishing what these future values should be, we based some of our
key balance sheet items based on a percentage of these total assets or total liabilities and
equity. Year after year, these particular line items of the balance sheet are of a similar
percentage for the past six years of total assets or total liabilities and equity.
We considered inventory to be a line item of interest considering we are in the retail
industry and sell our inventory to customers. Our inventory consistently has been near the
42% range of our total assets, accounts receivables are at a stable 1.75% of total assets, and
total current assets are near the 64% range of total assets. The non-current assets forecast at
36% of total assets, includes line items such as net property, plant, and equipment forecast at
27% of total assets and leasehold improvements of 22% of assets every year. We predict
85
these line items under assets to be very similar since the last six years seem to follow the same
pattern.
In the equity section, we deemed line items such as total shareholder’s equity and
retained earnings to be important for the continuing operations of any company. Although
shareholder’s equity stayed at a consistent 63% of total liabilities and shareholder’s equity, we
found retained earnings to be fairly volatile. From year 2005-2006, retained earnings jumped
14 percentage points when compared to total liabilities and shareholder’s equity. However, we
attempted to forecast this data even though the most recent year seemed to be abnormal and
making note that the validity of this forecast is not as strong as some of our other forecasts.
Because we have placed more importance on forecasting the equity section of the
balance sheet, the liabilities section claims more distortion than any other items posted on the
balance sheet forecast. The important line items we considered include accounts payable of
12%, total current liabilities of 22.15%, and total liabilities of 37% of total liabilities and
stockholder’s equity.
Men's Wearhouse Consolidated Balance Sheets (In thousands, except shares)
2001 2002 2003 2004 2005 2006AssetsCURRENT ASSETSCash and Cash Equivalents 5.38% 11.04% 15.05% 16.62% 17.83% 16.38%Short-term Investments 0.00% 0.00% 0.00% 0.00% 5.59% 0.00%Accounts Receivable, net 0.00% 2.60% 2.04% 2.10% 1.50% 1.55%Inventories 52.30% 46.82% 44.29% 40.90% 37.09% 40.89%Other Current Assets 5.18% 3.83% 3.53% 3.52% 2.95% 3.24% Total Current Assets 62.87% 64.29% 64.92% 63.12% 64.95% 62.07%
PROPERTY AND EQUIP., AT COSTLand 0.80% 0.78% 0.71% 0.89% 0.81% 0.83%Buildings 3.23% 3.08% 3.39% 5.09% 4.85% 5.79%Leasehold Improvements 21.51% 21.15% 22.38% 22.07% 21.75% 24.09%Furniture, Fixtures, and Equipment 28.30% 27.74% 27.53% 27.77% 27.07% 30.31% Total Property and Equip. 53.84% 52.76% 54.00% 55.82% 54.48% 61.02%Less accumulated depr. And amort. -24.44% -25.44% -28.51% -29.64% -30.48% -34.61% Net Property and Equipment 29.40% 27.32% 25.49% 26.18% 24.00% 26.40%TUXEDO RENTAL PRODUCT, net 0.00% 0.00% 0.00% 0.00% 4.68% 5.25%GOODWILL 0.00% 4.76% 5.00% 5.62% 5.13% 0.52%OTHER ASSETS, net 7.73% 3.64% 4.60% 5.08% 1.24% 1.10%Total Non-Current Assets 37.13% 35.71% 35.08% 36.88% 35.05% 37.93% TOTAL 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
LIABILITIES AND SHAREHOLDERS' EQUITYCURRENT LIABILITIESAccounts Payable 12.17% 12.83% 13.19% 13.31% 11.13% 10.14%Accrued Expenses 6.13% 7.19% 8.10% 8.35% 8.18% 8.68%Current Portion of Long-Term Debt 0.33% 0.26% 0.00% 0.00% 0.00% 0.00%Income Taxes Payable 2.18% 1.72% 2.97% 2.38% 1.88% 1.79% Total Current Liabilities 20.81% 22.01% 24.26% 24.04% 21.20% 20.62%LONG-TERM DEBT 5.26% 5.03% 14.92% 13.09% 18.27% 6.65%DEFERRED TAXES AND OTHER LIABILITIE 2.90% 3.84% 5.28% 5.61% 4.67% 4.02% Total Liabilities 28.97% 30.88% 44.45% 42.73% 44.13% 31.28%
COMMITMENTS AND CONTINGENCIESSHAREHOLDERS' EQUITYPreferred Stock, $.01 par value, 2,000,000 shares authorized 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Common Sock, $.01 par value, 100,000,000 shares authorized, 0.06% 0.06% 0.05% 0.04% 0.06% 0.06%Capital in excess of par 26.73% 25.50% 23.42% 21.98% 22.72% 26.08%Retained earnings 49.47% 51.67% 50.34% 51.69% 54.72% 68.59%Accumulated other comprehensive income -0.45% 0.01% 1.18% 1.76% 2.39% 2.14% Total 75.81% 77.23% 74.99% 75.47% 79.90% 96.87%Treasury Stock, 14,169,241 and 15,234,677 share -4.79% -8.11% -19.44% -18.20% -24.03% -28.16%Total Shareholders' Equity 71.03% 69.12% 55.55% 57.27% 55.87% 68.72% TOTAL 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Actual Financial Statements2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
1.75% 1.75% 1.75% 1.75% 1.75% 1.75% 1.75% 1.75% 1.75% 1.75%42.00% 42.00% 42.00% 42.00% 42.00% 42.00% 42.00% 42.00% 42.00% 42.00%
64.00% 64.00% 64.00% 64.00% 64.00% 64.00% 64.00% 64.00% 64.00% 64.00%
22% 22% 22% 22% 22% 22% 22% 22% 22% 22%
27% 27% 27% 27% 27% 27% 27% 27% 27% 27%
36% 36% 36% 36% 36% 36% 36% 36% 36% 36%100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
12% 12% 12% 12% 12% 12% 12% 12% 12% 12%8.50% 8.50% 8.50% 8.50% 8.50% 8.50% 8.50% 8.50% 8.50% 8.50%
22.15% 22.15% 22.15% 22.15% 22.15% 22.15% 22.15% 22.15% 22.15% 22.15%
37% 37% 37% 37% 37% 37% 37% 37% 37% 37%
54% 54% 54% 54% 54% 54% 54% 54% 54% 54%
63% 63% 63% 63% 63% 63% 63% 63% 63% 63%100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Forecast Financial Statements
86
Cash Flows
The most difficult of the financial statements is the statement of cash flows. To perform
the analysis on future cash flows from operations, we had to compare the CFFO/Sales and
CFFO/Gross Profit. We gathered that the CFFO/Sales is .09 and applied this rate for our CFFO
each progressive year. After further analyzing the CFFO/Gross Profit ratio of a consistent .2
from the last six years, we feel more assured that CFFO will increase at a 9% rate of sales or
20% rate of gross profit. Because of inconsistent fluctuations in the CFFO/Operating Income
and CFFO/Net Income ratios, we have decided to disregard them as a factor in deciding how
large of a CFFO growth rate to use.
To arrive at our forecasted cash flows from investing activities, we turned to our already
forecasted balance sheet and simply took the non-current assets from a forecasted year and
subtracted the amount from the most previous forecasted year. We feel that this is the most
accurate way in which to record the CFFI, considering we used data from the balance sheet,
which is more consistent, than using any numbers from the cash flows statement.
87
MENS WEARHOUSE INC10-K04/04/2007
Cash Flows2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
CASH FLOWS FROM OPERATING ACTIVITIES:Net earnings $42,355 $49,734 $71,356 $103,903 $148,575 $144,260 $157,965 $172,972 $189,404 $207,397 $227,100 $248,675 $272,299 $298,167 $326,493Adjustments to reconcile net earningsto net cash provided by operating activities:Depreciation and amortization $46,885 $50,993 $53,319 $61,874 $61,387Tuxedo rental product amortization $8,863 $15,341 $16,858Loss on disposition of assets $0 -$4,381 $0 $0 $1,365Loss on impairment of assets $0 $2,515 $2,169 $0 $0Write-off of deferred financing costs $0 $0 $1,263Deferred rent expense -$1,939 -$1,670 -$1,495 -$2,672 $2,021Stock-based compensation $122 $2,906 $6,965Deferred tax provision (benefit) $7,468 $342 $5,222 $2,983 -$1,470Increase in accounts receivable -$3,596 $2,809 -$1,116 -$209 -$223Increase in inventories $17,338 -$21,624 -$13,709 -$5,994 -$33,844Increase in tuxedo rental product -$19,834 -$30,555 -$22,346(Increase) decrease in other assets -$9,998 -$8,570 -$2,911 $606 -$3,374Increase (decrease) in accounts payable $19,613 $35,491 $28,060 -$725 -$18,112and accrued expensesIncrease (decrease) in income taxes payable -$4,951 $14,076 -$903 $6,987 $448Increase in other liabilities $1,809 $15 $836 $116 $1,281
Net cash provided by operating activities $114,984 $119,730 $129,979 $154,561 $160,794 $185,477 $203,098 $222,392 $243,519 $266,654 $291,986 $319,724 $350,098 $383,358 $419,776
CASH FLOWS FROM INVESTING ACTIVITIES:Capital expenditures -$47,380 -$49,663 -$85,392 -$66,499 -$72,904Net assets acquired -$4,500 -$11,000Purchases of available-for-sale investments -$106,850 -$279,120Proceeds from sales of available-for-sale $6,812 $44,075 $341,895investmentsInvestment in trademarks, tradenames -$2,619 -$1,644 -$556 -$141 -$1,506and other assets
Net cash used in investing activities -$43,187 -$55,807 -$96,948 -$129,415 -$11,635 -$22,599 -$33,563 -$36,751 -$40,242 -$44,065 -$48,252 -$52,836 -$57,855 -$63,351 -$69,369
CASH FLOWS FROM FINANCING ACTIVITIProceeds from issuance of common stock $3,035 $8,320 $10,876 $24,262 $10,823Proceeds from Issuance of Debt $130,000Bank borrowings $39,624 $71,695Principal payments on debt -$40,743 -$44,931 -$1,000 -$130,000Deferred financing costs -$1,075 -$3,916 -$276 -$556 -$330Cash dividends paid -$10,830 -$16,137 -$18,827 -$21,516 -$24,206 -$26,895 -$29,585 -$32,274 -$34,964 -$37,653 -$40,343Tax payments related to vested deferred -$677stock unitsExcess tax benefits from stock-based compensation $3,059Proceeds from Sale of Put Option Contracts $601Purchase of treasury stock -$28,058 -$109,186 -$11,186 -$90,280 -$40,289
Net cash provided by (used in) financing -$26,616 -$19,713 -$1,586 $5,121 -$168,244activities
Effect of exchange rate changes $1,099 $3,012 $1,417 $4,951 -$1,447
INCREASE ( DECREASE) IN CASH AND CAS $46,280 $47,222 $32,862 $35,218 -$20,532Balance at beginning of period $38,644 $84,924 $132,146 $165,008 $200,226
Balance at end of period $84,924 $132,146 $165,008 $200,226 $179,694
Actual Financial Statements Forecast Financials
88
SUPPLEMENTAL DISCLOSURES OF CASH FLOWINFORMATION:Cash paid during the year for:Interest $1,945 $2,091 $4,671 $4,600 $8,117
Income taxes $25,582 $15,863 $38,820 $50,105 $75,501
SUPPLEMENTAL SCHEDULE OF NONCASHAND FINANCING ACTIVITIES:Cash dividends declared $0 $2,653 $2,717
Additional capital in excess of par resulting $624 $1,572 $1,768 $9,646 $4,800from tax benefit related to stock-basedplans
Additional capital in excess of par resulting $0 $0 $0 $0 $8,318from tax benefit related to conversionof debt to common stock
Treasury stock contributed to employee $0 $500 $1,000 $1,500 $2,000stock plan
Capital expenditure purchases accrued $0 $1,000 $0 $0 $10,220in accounts payable and accrued expenses
CASH FLOWS FROM OPERATING ACTIVITIES: Average AssumeNet earnings 36.84% 41.54% 54.90% 67.22% 92.40% 14%Adjustments to reconcile net earningsto net cash provided by operating activities:Depreciation and amortization 40.78% 42.59% 41.02% 40.03% 38.18%Tuxedo rental product amortization 0.00% 0.00% 6.82% 9.93% 10.48%Loss on disposition of assets 0.00% -3.66% 0.00% 0.00% 0.85%Loss on impairment of assets 0.00% 2.10% 1.67% 0.00% 0.00%Write-off of deferred financing costs 0.00% 0.00% 0.00% 0.00% 0.79%Deferred rent expense -1.69% -1.39% -1.15% -1.73% 1.26%Stock-based compensation 0.00% 0.00% 0.09% 1.88% 4.33%Deferred tax provision (benefit) 6.49% 0.29% 4.02% 1.93% -0.91%Increase in accounts receivable -3.13% 2.35% -0.86% -0.14% -0.14%Increase in inventories 15.08% -18.06% -10.55% -3.88% -21.05%Increase in tuxedo rental product 0.00% 0.00% -15.26% -19.77% -13.90%(Increase) decrease in other assets -8.70% -7.16% -2.24% 0.39% -2.10%Increase (decrease) in accounts payable 17.06% 29.64% 21.59% -0.47% -11.26%and accrued expensesIncrease (decrease) in income taxes payable -4.31% 11.76% -0.69% 4.52% 0.28%Increase in other liabilities 1.57% 0.01% 0.64% 0.08% 0.80%
Net cash provided by operating activities 100.00% 100.00% 100.00% 100.00% 100.00%
CFFO/Sales 0.09 0.09 0.08 0.09 0.09 0.09 0.09 0.09 0.09 0.09 0.09 0.09 0.09 0.09 0.09CFFO/Gross Profit 0.25 0.23 0.22 0.22 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20CFFO/OI 1.66 1.46 1.10 0.94 0.72CFFO/NI 2.71 2.41 1.82 1.49 1.08
89
Cash Flows (revised)2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
CASH FLOWS FROM OPERATING ACTIVITIES:Net earnings $42,355 $49,734 $71,356 $103,903 $148,575 $144,878 $159,365 $175,230 $192,601 $211,622 $232,451 $255,258 $280,232 $307,579 $337,523Adjustments to reconcile net earningsto net cash provided by operating activities:Depreciation and amortization $46,885 $50,993 $53,319 $61,874 $61,387Tuxedo rental product amortization $8,863 $15,341 $16,858Loss on disposition of assets $0 -$4,381 $0 $0 $1,365Loss on impairment of assets $0 $2,515 $2,169 $0 $0Write-off of deferred financing costs $0 $0 $1,263Deferred rent expense -$1,939 -$1,670 -$1,495 -$2,672 $2,021Stock-based compensation $122 $2,906 $6,965Deferred tax provision (benefit) $7,468 $342 $5,222 $2,983 -$1,470Increase in accounts receivable -$3,596 $2,809 -$1,116 -$209 -$223Increase in inventories $17,338 -$21,624 -$13,709 -$5,994 -$33,844Increase in tuxedo rental product -$19,834 -$30,555 -$22,346(Increase) decrease in other assets -$9,998 -$8,570 -$2,911 $606 -$3,374Increase (decrease) in accounts payable $19,613 $35,491 $28,060 -$725 -$18,112and accrued expensesIncrease (decrease) in income taxes payable -$4,951 $14,076 -$903 $6,987 $448Increase in other liabilities $1,809 $15 $836 $116 $1,281
Net cash provided by operating activities $114,984 $119,730 $129,979 $154,561 $160,794 $185,477 $203,098 $222,392 $243,519 $266,654 $291,986 $319,724 $350,098 $383,358 $419,776
CASH FLOWS FROM INVESTING ACTIVITIES:Capital expenditures -$47,380 -$49,663 -$85,392 -$66,499 -$72,904Net assets acquired -$4,500 -$11,000Purchases of available-for-sale investments -$106,850 -$279,120Proceeds from sales of available-for-sale $6,812 $44,075 $341,895investmentsInvestment in trademarks, tradenames -$2,619 -$1,644 -$556 -$141 -$1,506and other assets
Net cash used in investing activities -$43,187 -$55,807 -$96,948 -$129,415 -$11,635 -$5,818 $0 $0 $0 $0 $0 $0 $0 $0 $0
CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from issuance of common stock $3,035 $8,320 $10,876 $24,262 $10,823Proceeds from Issuance of Debt $130,000Bank borrowings $39,624 $71,695Principal payments on debt -$40,743 -$44,931 -$1,000 -$130,000Deferred financing costs -$1,075 -$3,916 -$276 -$556 -$330Cash dividends paid -$10,830 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0Tax payments related to vested deferred -$677stock unitsExcess tax benefits from stock-based compensation $3,059Proceeds from Sale of Put Option Contracts $601Purchase of treasury stock -$28,058 -$109,186 -$11,186 -$90,280 -$40,289
Net cash provided by (used in) financing -$26,616 -$19,713 -$1,586 $5,121 -$168,244activities
Effect of exchange rate changes $1,099 $3,012 $1,417 $4,951 -$1,447
INCREASE ( DECREASE) IN CASH AND CASH EQU $46,280 $47,222 $32,862 $35,218 -$20,532Balance at beginning of period $38,644 $84,924 $132,146 $165,008 $200,226
Balance at end of period $84,924 $132,146 $165,008 $200,226 $179,694
SUPPLEMENTAL DISCLOSURES OF CASH FLOWINFORMATION:Cash paid during the year for:Interest $1,945 $2,091 $4,671 $4,600 $8,117
Income taxes $25,582 $15,863 $38,820 $50,105 $75,501
SUPPLEMENTAL SCHEDULE OF NONCASH INVEAND FINANCING ACTIVITIES:Cash dividends declared $0 $2,653 $2,717
Additional capital in excess of par resulting $624 $1,572 $1,768 $9,646 $4,800from tax benefit related to stock-basedplans
Additional capital in excess of par resulting $0 $0 $0 $0 $8,318from tax benefit related to conversionof debt to common stock
Treasury stock contributed to employee $0 $500 $1,000 $1,500 $2,000stock plan
Capital expenditure purchases accrued $0 $1,000 $0 $0 $10,220in accounts payable and accrued expenses
Actual Financial Statements Forecast Financials
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Cost of Capital Estimation
Using the Risk Free Rates and the S&P returns, we came up with our Market Risk
Premiums used for our regression analysis. Regression is done using the firms returns and the
risk free rates for a 3 month treasury, a one year, 3 year, 5 year, 7 year, and 10 year. Using
these 5 risk free rates, the analysis is done using 5 different numbers of observations. The
regression is done using different observations to see if the Beta is continuously stable and to
show us if there is any sort of structure shift. After doing this thoroughly and repeatedly for all
25 comparisons, our firm was left with negative R^2s and very unstable and negative Betas.
These negative R^2s illustrate that there is really no explanatory power for our company using
regression analysis. Our firms Beta is stated to be 1.5 on yahoofinance.com, nothing like the
regression results we acquired. This shows that there is absolutely no investor horizon in the
investor is using regression analysis.
3 Month 1 Year
Beta T Stat R2 Ke Beta T Stat R2 Ke
72 mo -0.312 -0.77384 -0.006 72 mo -0.311 -0.77308 -0.006
60 mo -0.71 -1.22608 0.0085 -1.66% 60 mo -0.706 -1.2217 0.0083 -1.63%
48 mo -0.518 -0.71095 -0.011 48 mo -0.515 -0.7076 -0.011
36 mo -0.464 -0.52069 -0.021 36 mo -0.463 -0.51913 -0.021
24 mo 0.5311 0.574835 -0.03 24 mo 0.5333 0.5777 -0.03
3 Year
Beta T Stat R2 Ke
72 mo -0.31 -0.77169 -0.006
60 mo -0.708 -1.22443 0.0084 -1.65%
48 mo -0.515 -0.70198 -0.011
36 mo -0.461 -0.51788 -0.021
24 mo 0.5368 0.582582 -0.03
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After calculating these betas and R^2s, it is clear that we will have to figure Ke
using another method than the CAPM model. We have estimated a Ke of 17% using the
backdoor method. For our growth rate, we used our estimate of 9.05%.
P/B-1 = Rf – Ke
Ke - g
After calculating our cost of equity, Ke, we calculated the cost of debt by
weighted our long term debt by the appropriate interest rates. We found our cost of
debt by assigning the liabilities their proper weight and multiplying them by the correct
interest rates. We have formulated our before tax weighted average cost of capital to
be 13.87%.
WACCbt = (343180/1096952)*.07 + (753722/1096952)*.17
Now that we have calculated the before tax weighted average cost of capital, we
are able to incorporate the federal tax rate of 35 % into this equation to find the after
5 Year 10 Year
Beta T Sta R2 Beta T Stat R2
72 mo -0.311 -0.77407 -0.006 72 mo -0.312 -0.77645 -0.006
60 mo -0.714 -1.23366 0.0088 -1.70% t60 mo
-0.721 -1.24572 0.0093 -1.76%
48 mo -0.512 -0.70331 -0.011 48 mo -0.512 -0.70444 -0.011
36 mo -0.464 -0.52129 -0.021 36 mo -0.467 -0.52441 -0.029
24 mo 0.5376 0.583467 -0.03 24 mo 0.5391 0.584722 -0.029
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tax weighted average cost of capital. We have calculated our before tax weighted
average cost of capital to be 13.10%
WACCbt = ((343180/1096952)*.07(1-.35)) + (753722/1096952)*.17
Conclusion
We have analyzed and measured the financial performance of Men’s Wearhouse
in comparison to their main competitor in the industry. The most beneficial ratios that
we examined are the following: liquidity ratios, leverage ratios, and capital structure
ratios. We have constructed a trend analysis along with a cross sectional analysis. We
have valuated liquidity, profitability, and capital structure ratios in an effort to
determine Men’s Wearhouse’s capability to liquidate assets, turn a profit, and how much
of our finances are debt and equity based. Men’s Wearhouse has been very efficient in
using their resources and their trends are in line with the industry. With the use of
these ratios, we have practiced forecasting methodology. We were able to forecast
future financials. We did so by studying historical data. The historical data we examine
is from past income statements, balance sheets, and statement of cash flows. We have
created common size financials for each of these statements. Our forecasting has
proven to be very promising for the future of Men’s Wearhouse. Finally, we have
estimated the cost of capital by using a set of methods. First, we used the backdoor
method to acquire a cost of equity. Then, we estimated the weighted average cost of
debt by using stated interest rates from Men’s Wearhouse’s 10K. Finally, we valued an
estimate of the before and after tax Weighted Average Cost of Capital. We were able
to do this by incorporating our previously estimated cost of equity and cost of debt. As
a result of the cost of equity, we have found Men’s Wearhouse’s weighted average cost
of capital before tax to be 13.87%.
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Analysis Valuations
The analysis performed and stated in previous paragraphs has allowed us to
obtain a strong foundation in how the Men’s Wearhouse operates in the men’s specialty
clothing industry. By taking into account their future forecasts and their weighted
average cost of capital, we will be able to identify if their observed stock price of the
Men’s Wearhouse aligns with our predicted intrinsic values allowing us to recognize if
their stock is fairly valued, undervalued, or overvalued. First, the method of
comparables is a valuation model that factors in up-to-date financial statistics from the
Men’s Wearhouse and their competitors to arrive at an industry average. However, the
method of comparables is not very reliable because estimated prices are found using
industry averages. Some factor’s that may affect our competitor’s such as large
department stores may not necessarily affect the operations of the Men’s Wearhouse
implying that using the industry average is not always appropriate to use as a
comparison.
To obtain a more accurate assessment of the value of the stock, we will utilize
theoretical valuation models. These models make use of the WACC (weighted average
cost of capital) and Ke (cost of equity) disclosed in previous paragraphs. These
valuation models include the Dividend Discount Model, the Discounted Free Cash Flows
Model, the Residual Income Model, and the Abnormal Earnings Growth Model.
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Method of Comparables
The Method of Comparables uses an average of our competitor’s ratios to find a
price per share for our firm. It also allows us to compare Men’s Wearhouse’s ratios with
the rest of the industry. Our main competitors include Nordstrom, Jos A Banks, Macys
and Brooks Brothers. We could not find any information for Brooks Brothers because
they are not publicly traded.. We computed an industry average for all of the ratios.
The method of comparables values our firm solely based on our competitors numbers.
This can be unreliable because it is not likely that Mens Wearhouse will perform like the
average of the rest of the industry. The number that were estimated from this method
did come close to the Mens Wearhouse listed price for November 1st. The prices were
moslty all lower, meaning this method illustrates that the Mens Wearhouse is
overvalued at $40.47 per share. We will take a closer look into each valuation below.
Trailing P/E $41.79 Fairly
Forward P/E $33.82 Overvalued
P/B $50.05 Undervalued
P/FCF NA
PEG $29.72 Overvalued
EV/EBITDA $33.30 Overvalued
P/EBITDA $33.27 Overvalued
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Trailing P/E
The Price to Earnings ratios uses the PPS we derived from yahoofinance.com for
us and our competing firms on November 1st,2007, and current earnings per share and
price to earnings ratios. We found an industry average for the P/E of 12.74. The Mens
Wearhouse P/E ratio is slightly smaller than the industry average, and the smallest of all
of its competitors. This means that Men’s Wearhouse’s earnings are not growing as
quickly as the rest of its industry. Using the 12.74 average times our earnings per share
of 3.28, Mens Wearhouse Price using the Trailing P/E is 41.79. This ratio shows our
company is fairly valued at its price of $40.47.
Forward P/E
PPS EPS P/E MW Price
Mens Wearhouse 40.47 3.57 11.76 36.8067
Nordstrom 37.75 3.49 10.81
Jos A Banks 27.63 3.12 8.85
Macys 31.54 2.80 11.27
PPS EPS P/E MW Price
Mens Wearhouse 40.47 3.28 9.47 41.79
Nordstrom 37.75 2.71 11.88
Jos A Banks 27.63 2.56 10.25
Macys 31.54 1.67 16.09
Ind Average 12.74
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Ind Average 10.31
The forward looking price earnings ratio uses forecasted earnings per share.
Using the price per share and our estimated earnings per share we get a P/E ratio.
Then we found the industry average of the price to earnings which is quite close to that
of Mens Wearhouse. We multiplied our forward looking earnings per share by the
industry average for P/E of 10.31 to get a share price of $36.81. This being lower than
our price of $40.47, Mens Wearhouse is overvalued in this instance.
Price to Free Cash Flows
The Price to Free Cash Flows ratio is irrelevant because Mens Wearhouse
currently has negative FCF of ($20532.00).
Price to
Book
The Price to book ratio uses the average industry price to book value of
equity with our firms book value of equity per share. Price to books gives us an idea of
how much equity compares to our overall price. Our industry average of P/B is 3.25,
which is higher than our P/B ratio. Using Men’s Wearhouses BPS of 15.39 times this
PPS BPS P/B MW Price
Mens Wearhouse 40.47 15.39 2.62 50.05
Nordstrom 37.75 4.22 6.34
Jos A Banks 27.63 2.13 2.04
Macys 31.54 1.28 1.38
Ind Average 3.25
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average P/B gives Mens Wearhouse a PPS of $50.05. This valuation illustrates that the
Mens Wearhouse is undervalued at $40.47 per share.
Price Earnings Growth (PEG)
PPS EPS PEG MW Price
Mens Wearhouse 40.47 3.28 0.68 29.72
Nordstrom 37.75 2.71 1.09
Jos A Banks 27.63 2.56 0.89
Macys 31.54 1.67 1.03
Ind Average 1.003
MW Growth Rate 9.03%
Price Earnings Growth incorporates our firms estimated growth in the price earnings ratio. To find our PPS for this method we again needed an industry average PEG. This turned out to be 1.003, we then plugged this and our EPS into a formula to derive the PPS.
1.003 = P/3.28/g
This gave us an estimated share price of $29.72, considerably lower than our historical price of $40.47. Unlike its previous ratios, using the price earnings growth ratio Mens Wearhouse is overvalued.
Enterprise Value/EBITDA
This method uses enterprise value compared to EBTIDA. Enterprise value is the firms price plus its book value of liabilities and minus cash and investments. EBITDA is earnings before interest, taxes, depreciation and amortization. We used a
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formula to obtain a price per share for Mens Wearhouse using the industry average and our numbers from our 10-K.
Ind Avg=(P*S+BVL-Cash-Investments)/EBITDA
6.6603=(P*69.154+82.03-134.93-0.449)/233.724
Solving for P gives us the price per share of Mens Wearhouse. Using simple algebra we f
Price/EBITDA
Price to EBITDA compares the firms price to the firms earnings before interest,
taxes, depreciation and amortization. Using the historical prices from November 1st,
2007 and their most recent EBITDA from their income statements we found a P/EBITDA
ratio for ourselves and each of our competitors. The average for industry was 142.36.
This average was multiplied by Mens Wearhouse’s EBITDA of .23 (in billions) to get a
share price of $33.27. Once again our company is overvalued.
Conclusion
The Method of Comparables has given us all three of the different results for
valuation; undervalued, fairly valued, and over valued. The majority of the ratios
PPS EBITDA(in billions) P/EBITDA MW Price
Mens Wearhouse 42.00 0.23 179.70 33.27
Nordstrom 37.75 1.16 32.46
Jos A Banks 27.63 0.07 378.00
Macys 31.54 1.90 16.63
Ind Average 142.36
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however have demonstrated that Mens Wearhouse is slightly overvalued. As said
before, this method is not the strongest and most reliable for a company because they
will not all perform at the industry average. Every company in every industry has its
own unique success factors, accounting policies and structure meaning it is impossible
to assume they will all perform alike.
Intrinsic Valuations
Intrinsic valuations are a more realistic way of estimating the value of stock than
the method of comparables. These valuations are based off of theoretical principles.
The four models we used to determine these valuations are the following: Dividend
Discount Model, Discounted Free Cash Flows Model, Residual Income Model, and
Abnormal Earnings Growth Model. We used previously calculated ratios and estimates
to obtain intrinsic values for each of these models. We estimated share prices that are
valued at November 1, 2007, when Men’s Wearhouse’s actual price per share was
$40.47. The following is a further discussion of our methods of valuations.
Discounted Dividends Model
Shareholders determine the value of their investment in a firm by the dividends
that they will receive. The Discounted Dividends Model states a company’s value for
shareholders as the present value of forecasted future dividends. In general, this
approach discounts future dividends back to the present value of a firm. The dividends
discount model has the least amount of explanatory power of all the models that we
use. It not a reliable method of valuation because future economic conditions that
were not foreseen could occur, affecting dividends. For instance, Men’s Wearhouse
could go bankrupt. We assume, and make estimates on this assumption, that this
company will continue running indefinitely, but there is no way of knowing for sure.
Men’s Wearhouse did not start paying dividends until the end of the fiscal year of 2006.
We use a dividend growth rate of $.04 a year because this year they expect a $.01
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growth in declared dividends each quarter. One reason for recent declared dividends is
the large growth the firm has experienced over the past few years. However, the firm
does not anticipate maintaining high growth rates because the company believes they
can only manage about 50 more stores (Men’s Wearhouse 2007 10K). Therefore, it is
unlikely that their dividends with continue to increase over the next 10 years as we
forecasted. Once we forecasted expected future dividends for the next 10 years, we
discounted each individual year back using the proper present value factor and the
estimated cost of equity. In the future, we expect Men’s Wearhouse to pay dividends in
the form of a perpetuity starting now and moving forward. Next, we added all the
present value of dividends for each year to come to the total present value of annual
dividends. We then found the present value of the terminal perpetuity by multiplying
the continuing terminal perpetuity by the present value factor of 2016. Next, we added
the present values of annual dividends and the terminal perpetuity to find the estimated
price per share.
Sensitivity Analysis
6% 7% 8% 9%8% $19.83 $36.62 NA NA
10% $9.87 $12.24 $16.97 $31.1612% $6.57 $7.37 $8.57 $10.5815% $4.37 $4.63 $4.97 $5.4217% $3.57 $3.72 $3.90 $4.12
Cost
of
Equi
ty
Perpetuity Growth Rate (g)
Overvalued < 36.42Fair Value +/- 10%Undervalued > 44.52NA
With a cost of equity of 17% and a growth rate of 9% we estimated the price
per share to be $4.12. Compared to our observed share price of $40.47, the model
shows that the firm is drastically over valued. However, since the Men’s Wearhouse has
only paid dividends once, this model does not hold value in our analysis of the firm.
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Discounted Free Cash Flows Model
In order to begin valuations using the Discounted Free Cash Flows Model we
need the weighted average cost of capital, the perpetuity growth rate, and the free
cash flows of Men’s Wearhouse. The weighted average cost of capital is the discount
rate that we use in this model. By taking the ten year forecasted amount of Cash flows
from operations and subtracting investing activities, we came up with the Men’s
Wearhouse’s Free Cash Flows. Then, we took our WACC of 13.8 as the discount factor
and from that found our present value factor. We take this present value factor and
multiply it by the ten years of Free Cash Flows. The Present Value of annual cash flows
is equal to the sum of these, $1,115,588. We forecasted year 2017 Free Cash Flow and
from that we determined the perpetuity. We then divided the value of the perpetuity
by the difference between the WACC and the growth rate. Next, we multiplied that by
the present value factor in year ten in order to discount it back to the present value. To
find the total value of Men’s Wearhouse’s equity, we found the sum of the present
value of annual cash flows and present value of perpetuity and subtracted the book
value of liabilities from this sum. We forecasted that total value of equity out two
months to get a value for November 1, 2007, which is $2,393,797. The forecasted
value of equity was then divided by the number of shares to give us the Men’s
Wearhouse’s intrinsic share price of $35.60. Our implied share price with a 14% WACC
and 8% growth rate is $39.71.
Sensitivity Analysis
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5% 6% 7% 8% 9%10% $43.77 $51.60 $64.65 $90.76 $169.0811% $38.84 $44.10 $51.99 $65.14 $91.4412% $35.34 $39.13 $44.43 $52.38 $65.6313% $32.74 $35.60 $39.42 $44.76 $52.7714% $30.74 $32.98 $35.87 $39.71 $45.09
Perpetuity Growth Rate (g)W
ACC
(BT)
Overvalued < 36.42Fair Value +/- 10%Undervalued > 44.52NA
Determined from the sensitivity analysis, Men’s Wearhouse is apparently fairly
valued at an 8% growth rate. We previously had predicted that the Men’s Wearhouse
would consistently grow at 9% each year. Based on this model alone, the Men’s
Wearhouse is a fairly valued company.
Residual Income Model
The Residual Income Model (RI) was the most significant valuation model that
we used to assess Men’s Wearhouse. This model is so important because it has the
greatest explanatory power out of all the models we used. The first step in the residual
income model is to find the present value of a firm’s residual income. To find the
residual income, we multiplied last years book value of equity by cost of equity, which
gave us normal earnings. After finding normal earnings, we subtracted this value from
the earnings per share of the current year to give us the residual income. We used the
cost of equity as our discount factor, and then we found the present value factor to
bring each year’s residual income back to this year. The 2016 residual income was
used as our value of perpetuity residual income and discounted back by dividing this by
the difference between the cost of equity and growth rate of zero. After this, we were
able to find the present value of the perpetuity. These two present values were then
added to the ending PVE for 2007 and divided by the number of shares to give us an
intrinsic price per share at November 1, 2007.
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Sensitivity Analysis
8.5% 9.0% 9.5% 10.0% 12.0%11% $31.53 $34.91 $40.55 $51.83 NA12% $21.92 $22.80 $24.02 $25.86 $35.0413% $16.61 $16.75 $16.93 $17.18 $20.6114% $13.24 $13.13 $12.99 $12.82 $11.2917% $7.95 $7.73 $7.47 $7.18 $5.44
Growth RateCo
st o
f Eq
uity
Overvalued < 36.42Fair Value +/- 10%Undervalued > 44.52NA
The model estimates that the implied share price is $7.73 with a cost of equity of 17%
and a growth rate of 9%. When compared to the actual share price of $40.47, we
found Men’s Wearhouse to be drastically overvalued. With a cost of equity of 11% and
a growth rate of 9.5%, will the model show that the firm is fairly valued. However, it is
highly unlikely that the cost of equity will drop by 6%.
Abnormal Earnings Growth Model
The Abnormal Earnings Growth Model (AEG) consists of calculations that involve a
company’s earnings and dividends. This model helps us better understand the theory
of the price earnings ratio. This model differs from the other intrinsic models in that it
discounts back to the first year instead of year zero. Also, the perpetuity in this model
stays constant. The AEG model is a valuable tool to use for analysis because of its
accuracy. The fact that it is directly linked to the residual income model helps prove
this point. For instance, the residual income in year two minus the residual income for
year one is equal to the abnormal earnings growth for year two. To calculate the
abnormal earnings growth model for Men’s Wearhouse, we started by multiplying our
forecasted dividends by our cost of equity, 17%. From there, we added that total to
the annual earnings to get cumulative dividend earnings. Next, we found our normal
income by using the formula:
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Normal Income= (1+Ke)(Earnings t-1)
The last step to this model that we performed was to calculate each individual’s year’s
abnormal earnings growth. To do this, we took the difference between cumulative
dividend earnings and normal earnings to establish whether value has been created,
maintained, or destroyed. We discounted each year’s abnormal earnings growth and
the perpetuity with the appropriate present value discount factor including the cost of
equity.
Sensitivity Analysis
Perpetuity Growth Rate (g)0% 2% 4% 6% 8%
8% $43.35 $46.33 $52.27 $70.10 NA9% $33.05 $34.26 $36.43 $41.49 $66.82
10% $25.97 $26.34 $26.95 $28.17 $31.8314% $12.37 $12.05 $11.60 $10.93 $9.8017% $8.40 $8.13 $7.78 $7.30 $6.60
Overvalued < 36.42Fair Value +/- 10%Undervalued > 44.52NA
Cost
of
Equi
ty (
Ke)
With the Men’s Wearhouse’s 17% cost of equity and growth rate of 8%, the
model values the firm at $6.60. However, at a cost of equity of 9% and a growth rate
of 6%, the model would prove our stock to be fairly valued. This is very unlikely
because the cost of debt is about 7% and the cost of equity should always be well
above this. Therefore, the AEG model proves that the Men’s Wearhouse is over priced.
Conclusion
105
After using the valuation models we have determined that the Men’s Wearhouse
is over priced. Only with a very low cost of equity would the firm be fairly valued at the
current price of $40.47. It is very unlikely that the firm would be able to lower their cost
of equity to the point that the firm would be accurately valued.
The Discounted Dividends Model is not a reliable model to value a firm,
especially for the Men’s Wearhouse because they have only paid dividends for one year.
This model showed that the firm is overvalued. Next, the Discounted Free Cash Flows
Model is the only model that shows our firm to be fairly valued. This is the only model
that uses WACC in the sensitivity analysis. The third and most accurate model we used
was the Residual Income Model. This model also overvalued the Men’s Wearhouse with
a cost of equity of 17% and a growth rate of 9%. Only with a cost of equity of 11%
and a growth rate of 9.5% would the Men’s Wearhouse be fairly priced using the
Residual Income Model. Finally, the AEG Model at a 17% cost of equity and an 8%
growth rate also overvalued the Men’s Wearhouse. If the firm was able to lower their
cost of equity to 9% and growth to 6% would the Men’s Wearhouse would be fairly
valued at $40.47. However this is highly unlikely because the cost of debt is 7% and
the cost of equity is always higher. Therefore, the Men’s Wearhouse is overvalued.
Credit Analysis
Credit Analysis is done by using the Altman Z Score, created by Edward Altman.
People have been using this method since the 60’s to predict bankruptcy. The Z Score
weights five financial ratios to find a probability of bankruptcy or failure. Below is the
Altman Z Score formula and our scores for the past five years.
Altman Z Score = 1.2 (Net Working Capital/Total Assets) + 1.4 (Retained
Earnings/Total Assets) + 3.3 (EBIT/Total Assets) + .6 (Mkt Value Equity/BVL) + 1.0
(Sales/Total Assets)
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2002 2003 2004 2005 2006 Z Score 3.52 3.18 3.32 3.50 4.32
Any score under 1.82 is at extreme risk for bankruptcy according to this
weighted score, and anything over 2.67 is safe. In between is a very grey area of risk.
Our Altman Z Scores are all very favorable and all have been over three for the past
five years, making Mens Wearhouse very far from bankruptcy and credit risk. The score
is also continuously rising to a current score of 4.32, which is exceptional. Using this
rising data it would be safe to forecast Mens Wearhouse will not be at risk in the near
future either.
Analyst Recommendation
After researching the Men’s Wearhouse industry analysis, accounting analysis,
future forecasts, we believe we have a strong foundation in understanding how the
Men’s Wearhouse operates within the men’s specialty retail industry and how they
stand amongst their competitors. With only a few main players in the men’s specialty
retail industry, the Men’s Wearhouse possesses the main key success factors to allow
them to be the leader within this industry and continue to grow a very optimistic rate.
The Men’s Wearhouse utilizes relationships with suppliers to provide them with a large
economies of scale so that they remain extremely competitive and trickle their discount
prices to their customers allowing them to boast large numbers in sales.
Men’s Wearhouse matches up positively when measured up against their
competitors within their industry during ratio analysis. On the other hand, a more
realistic view of our company is produced through the theoretical intrinsic valuation
models. These results produced much lower stock prices than the stated current stock
107
price of $40.47 as of November 1, 2007. These low stock prices based on our
valuations depict that investors have an idealistically lower expectation of the
company’s cost of capital. Because of the Men’s Wearhouse failure to convert their
operating leases into capital leases, the Men’s Wearhouse understates their liabilities
which creates a much larger debt to equity ratio than at first perceived. Obviously, the
Men’s Wearhouse does not record these leases in the liabilities because it makes the
company look somewhat unfavorable. This off-balance sheet accounting manipulation
is normal within this industry and may be misleading for future investors. Because of
the results of our analysis and intrinsic values, we deem Men’s Wearhouse as
overvalued and approve a sell recommendation.
Appendix
Liquidity
Profitability
Current Ratio Quick Asset Ratio 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006MW 3.02 3.02 2.68 2.63 3.06 MW 0.26 0.62 0.70 0.78 1.18JOSB 2.01 1.77 2.22 1.89 1.92 JOSB 0.09 0.21 0.08 0.08 0.13 A/R Turnover Days Sales Outstanding 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006MW 0.00 69.62 86.32 82.75 111.78 MW 0.00 5.24 4.23 4.41 3.27JOSB 102.98 105.89 88.67 96.84 84.65 JOSB 3.54 3.45 4.12 3.77 4.31 Inventory Turnover Days Supply Inventory 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006MW 2.24 2.44 2.43 2.53 2.38 MW 162.99 149.51 150.44 144.27 153.54JOSB 1.70 1.63 1.22 1.39 1.18 JOSB 214.81 224.27 298.55 263.31 310.05
Working Capital Turnover
2002 2003 2004 2005 2006 MW 4.29 4.28 4.33 4.44 3.83 JOSB 6.45 7.15 4.89 6.67 5.60
108
Capital Structure
Debt to Equity Times Interest Earned
2002 2003 2004 2005 2006 2002 2003 2004 2005 2006
MW 0.41 0.45 0.80 0.75 0.79 MW 17.83 18.47 24.80 34.45 77.93
JOSB 1.08 1.07 1.32 1.04 0.98 JOSB 17.83 18.47 24.80 34.45 77.93
Method of Comparables
Gross Profit Margin
Operating Expense Ratio
2002 2003 2004 2005 2006 2002 2003 2004 2005 2006MW 35.08% 36.87% 38.99% 40.42% 43.34% MW 29.72% 31.00% 31.35% 30.83% 31.44%JOSB 54.88% 57.50% 60.36% 61.90% 61.94% JOSB 46.62% 46.98% 48.75% 48.45% 48.46% Net Profit Margin
Asset Turnover
2002 2003 2004 2005 2006 2002 2003 2004 2005 2006MW 3.27% 3.57% 4.61% 6.02% 7.89% MW 1.80 1.81 1.76 1.74 1.68JOSB 4.45% 5.43% 6.57% 7.59% 7.91% JOSB 2.24 2.20 1.86 1.99 1.79 Return on Assets
Return on Equity
2002 2003 2004 2005 2006 2002 2003 2004 2005 2006MW 5.94% 6.93% 9.28% 11.83% 14.96% MW 8.56% 9.75% 13.42% 21.30% 26.12%JOSB 12.19% 15.01% 17.98% 17.57% 18.53% JOSB 23.72% 31.16% 37.29% 40.77% 37.81%
Trailing P/E $41.79 Fairly
Forward P/E $33.82 Overvalued
P/B $50.05 Undervalued
P/FCF NA
PEG $29.72 Overvalued
EV/EBITDA $33.30 Overvalued
P/EBITDA $33.27 Overvalued
109
Trailing P/E
Forward P/E
PPS EPS P/E MW Price
Mens Wearhouse 40.47 3.57 11.76 36.8067
Nordstrom 37.75 3.49 10.81
Jos A Banks 27.63 3.12 8.85
PPS EPS P/E MW Price
Mens Wearhouse 40.47 3.28 9.47 41.79
Nordstrom 37.75 2.71 11.88
Jos A Banks 27.63 2.56 10.25
Macys 31.54 1.67 16.09
Ind Average 12.74
110
Macys 31.54 2.80 11.27
Ind Average 10.31
Price to Book
PPS BPS P/B MW Price
Mens Wearhouse 40.47 15.39 2.62 50.05
Nordstrom 37.75 4.22 6.34
Jos A Banks 27.63 2.13 2.04
Macys 31.54 1.28 1.38
111
Price Earnings Growth
PPS EPS PEG MW Price
Mens Wearhouse 40.47 3.28 0.68 29.72
Nordstrom 37.75 2.71 1.09
Jos A Banks 27.63 2.56 0.89
Macys 31.54 1.67 1.03
Ind Average 1.003
MW Growth Rate 9.03%
Ind Average 3.25
112
Price/EBITDA
Regression Analysis
PPS EBITDA(in billions) P/EBITDA MW Price
Mens Wearhouse 42.00 0.23 179.70 33.27
Nordstrom 37.75 1.16 32.46
Jos A Banks 27.63 0.07 378.00
Macys 31.54 1.90 16.63
Ind Average 142.36
113
3 month at 72 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.092098R Square 0.008482Adjusted R -0.00568Standard E 0.118059Observatio 72
ANOVAdf SS MS F Significance F
Regression 1 0.008346 0.008346 0.598826 0.441632Residual 70 0.975655 0.013938Total 71 0.984001
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.020764 0.01399 1.484248 0.142232 -0.00714 0.048666 -0.00714 0.048666X Variable -0.31185 0.402986 -0.77384 0.441632 -1.11558 0.491885 -1.11558 0.491885
114
3 month at 60 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.158946R Square 0.025264Adjusted R 0.008458Standard E 0.116475Observatio 60
ANOVAdf SS MS F Significance F
Regression 1 0.020394 0.020394 1.503277 0.225123Residual 58 0.786854 0.013566Total 59 0.807248
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.030689 0.015614 1.965481 0.054153 -0.00057 0.061943 -0.00057 0.061943X Variable -0.70966 0.578801 -1.22608 0.225123 -1.86825 0.448939 -1.86825 0.448939
3 month at 48 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.104253R Square 0.010869Adjusted R -0.01063Standard E 0.106821Observatio 48
ANOVAdf SS MS F Significance F
Regression 1 0.005768 0.005768 0.505456 0.480702Residual 46 0.524897 0.011411Total 47 0.530665
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.020388 0.015939 1.279078 0.207285 -0.0117 0.052472 -0.0117 0.052472X Variable -0.51813 0.728781 -0.71095 0.480702 -1.98509 0.94883 -1.98509 0.94883
115
3 month at 36 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.088943R Square 0.007911Adjusted R -0.02127Standard E 0.114189Observatio 36
ANOVAdf SS MS F Significance F
Regression 1 0.003535 0.003535 0.271113 0.60596Residual 34 0.443329 0.013039Total 35 0.446864
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.021274 0.019677 1.081167 0.287232 -0.01871 0.061262 -0.01871 0.061262X Variable -0.46444 0.891985 -0.52069 0.60596 -2.27718 1.348288 -2.27718 1.348288
116
3 month at 24 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.121645R Square 0.014798Adjusted R -0.02998Standard E 0.090678Observatio 24
ANOVAdf SS MS F Significance F
Regression 1 0.002717 0.002717 0.330436 0.571235Residual 22 0.180893 0.008222Total 23 0.18361
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.022091 0.019507 1.132463 0.269632 -0.01836 0.062547 -0.01836 0.062547X Variable 0.531138 0.923982 0.574836 0.571235 -1.38508 2.44736 -1.38508 2.44736
117
1 year at 72 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.092009R Square 0.008466Adjusted R -0.0057Standard E 0.11806Observatio 72
ANOVAdf SS MS F Significance F
Regression 1 0.00833 0.00833 0.597657 0.442076Residual 70 0.975671 0.013938Total 71 0.984001
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.02069 0.01398 1.479944 0.143375 -0.00719 0.048573 -0.00719 0.048573X Variable -0.31108 0.402384 -0.77308 0.442076 -1.11361 0.491454 -1.11361 0.491454
118
1 year at 60 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.158392R Square 0.025088Adjusted R 0.008279Standard E 0.116486Observatio 60
ANOVAdf SS MS F Significance F
Regression 1 0.020252 0.020252 1.49255 0.226764Residual 58 0.786996 0.013569Total 59 0.807248
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.030517 0.015582 1.958507 0.054985 -0.00067 0.061708 -0.00067 0.061708X Variable -0.70633 0.578155 -1.2217 0.226764 -1.86363 0.450971 -1.86363 0.450971
1 year at 48 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.103767R Square 0.010768Adjusted R -0.01074Standard E 0.106827Observatio 48
ANOVAdf SS MS F Significance F
Regression 1 0.005714 0.005714 0.500697 0.482764Residual 46 0.524951 0.011412Total 47 0.530665
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.020254 0.015898 1.274019 0.209056 -0.01175 0.052256 -0.01175 0.052256X Variable -0.51512 0.72798 -0.7076 0.482764 -1.98046 0.950229 -1.98046 0.950229
119
1 year at 36 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.08868R Square 0.007864Adjusted R -0.02132Standard E 0.114191Observatio 36
ANOVAdf SS MS F Significance F
Regression 1 0.003514 0.003514 0.269498 0.607032Residual 34 0.44335 0.01304Total 35 0.446864
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.021185 0.019638 1.078778 0.288281 -0.01872 0.061095 -0.01872 0.061095X Variable -0.4626 0.89111 -0.51913 0.607032 -2.27356 1.348349 -2.27356 1.348349
120
1 year at 24 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.122242R Square 0.014943Adjusted R -0.02983Standard E 0.090671Observatio 24
ANOVAdf SS MS F Significance F
Regression 1 0.002744 0.002744 0.333738 0.569333Residual 22 0.180866 0.008221Total 23 0.18361
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.022119 0.019481 1.135424 0.268417 -0.01828 0.062521 -0.01828 0.062521X Variable 0.533315 0.92317 0.5777 0.569333 -1.38122 2.447852 -1.38122 2.447852
3 year at 72 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.091845R Square 0.008436Adjusted R -0.00573Standard E 0.118062Observatio 72
ANOVAdf SS MS F Significance F
Regression 1 0.008301 0.008301 0.595511 0.442893Residual 70 0.9757 0.013939Total 71 0.984001
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.020551 0.013964 1.471707 0.145582 -0.0073 0.048402 -0.0073 0.048402X Variable -0.3097 0.401327 -0.77169 0.442893 -1.11012 0.49072 -1.11012 0.49072
121
3 year at 60 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.158737R Square 0.025197Adjusted R 0.008391Standard E 0.116479Observatio 60
ANOVAdf SS MS F Significance F
Regression 1 0.020341 0.020341 1.499229 0.22574Residual 58 0.786908 0.013567Total 59 0.807248
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.0303 0.015533 1.950652 0.055936 -0.00079 0.061393 -0.00079 0.061393X Variable -0.70782 0.578078 -1.22443 0.22574 -1.86497 0.449333 -1.86497 0.449333
122
3 year at 48 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.102951R Square 0.010599Adjusted R -0.01091Standard E 0.106836Observatio 48
ANOVAdf SS MS F Significance F
Regression 1 0.005624 0.005624 0.492772 0.48623Residual 46 0.52504 0.011414Total 47 0.530665
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.020107 0.015857 1.268053 0.21116 -0.01181 0.052025 -0.01181 0.052025X Variable -0.51052 0.727254 -0.70198 0.48623 -1.9744 0.953371 -1.9744 0.953371
3 year at 36 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.088468R Square 0.007827Adjusted R -0.02136Standard E 0.114194Observatio 36
ANOVAdf SS MS F Significance F
Regression 1 0.003497 0.003497 0.268202 0.607894Residual 34 0.443366 0.01304Total 35 0.446864
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.021159 0.019629 1.077932 0.288653 -0.01873 0.061049 -0.01873 0.061049X Variable -0.46086 0.889886 -0.51788 0.607894 -2.26932 1.34761 -2.26932 1.34761
123
3 year at 24 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.12326R Square 0.015193Adjusted R -0.02957Standard E 0.090659Observatio 24
ANOVAdf SS MS F Significance F
Regression 1 0.00279 0.00279 0.339402 0.566098Residual 22 0.180821 0.008219Total 23 0.18361
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.02203 0.019511 1.129125 0.271007 -0.01843 0.062494 -0.01843 0.062494X Variable 0.536789 0.921396 0.582582 0.566098 -1.37407 2.447648 -1.37407 2.447648
124
5 year at 72 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.092126R Square 0.008487Adjusted R -0.00568Standard E 0.118059Observatio 72
ANOVAdf SS MS F Significance F
Regression 1 0.008351 0.008351 0.599186 0.441495Residual 70 0.97565 0.013938Total 71 0.984001
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.020445 0.013953 1.465303 0.147316 -0.00738 0.048272 -0.00738 0.048272X Variable -0.31056 0.401201 -0.77407 0.441495 -1.11073 0.489612 -1.11073 0.489612
5 year at 60 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.159903R Square 0.025569Adjusted R 0.008769Standard E 0.116457Observatio 60
ANOVAdf SS MS F Significance F
Regression 1 0.020641 0.020641 1.521919 0.222305Residual 58 0.786608 0.013562Total 59 0.807248
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.030125 0.015488 1.944986 0.05663 -0.00088 0.061128 -0.00088 0.061128X Variable -0.71376 0.578571 -1.23366 0.222305 -1.8719 0.444375 -1.8719 0.444375
125
5 year at 48 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.103144R Square 0.010639Adjusted R -0.01087Standard E 0.106834Observatio 48
ANOVAdf SS MS F Significance F
Regression 1 0.005646 0.005646 0.494644 0.485408Residual 46 0.525019 0.011413Total 47 0.530665
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.020008 0.015823 1.264522 0.212412 -0.01184 0.051857 -0.01184 0.051857X Variable -0.51151 0.727287 -0.70331 0.485408 -1.97546 0.952445 -1.97546 0.952445
126
5 year at 36 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.089045R Square 0.007929Adjusted R -0.02125Standard E 0.114188Observatio 36
ANOVAdf SS MS F Significance F
Regression 1 0.003543 0.003543 0.271738 0.605547Residual 34 0.443321 0.013039Total 35 0.446864
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.021147 0.019615 1.078107 0.288576 -0.01872 0.061009 -0.01872 0.061009X Variable -0.464 0.890108 -0.52129 0.605547 -2.27292 1.344916 -2.27292 1.344916
5 year at 24 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.123444R Square 0.015238Adjusted R -0.02952Standard E 0.090657Observatio 24
ANOVAdf SS MS F Significance F
Regression 1 0.002798 0.002798 0.340433 0.565513Residual 22 0.180812 0.008219Total 23 0.18361
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.022024 0.019511 1.128779 0.27115 -0.01844 0.062488 -0.01844 0.062488X Variable 0.537625 0.921432 0.583467 0.565513 -1.37331 2.448557 -1.37331 2.448557
127
10 year 72 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.092406R Square 0.008539Adjusted R -0.00562Standard E 0.118056Observatio 72
ANOVAdf SS MS F Significance F
Regression 1 0.008402 0.008402 0.602873 0.4401Residual 70 0.975599 0.013937Total 71 0.984001
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.020307 0.01394 1.45678 0.149648 -0.00749 0.04811 -0.00749 0.04811X Variable -0.31152 0.401206 -0.77645 0.4401 -1.1117 0.488664 -1.1117 0.488664
128
10 year at 60 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.161426R Square 0.026058Adjusted R 0.009266Standard E 0.116428Observatio 60
ANOVAdf SS MS F Significance F
Regression 1 0.021036 0.021036 1.551823 0.217875Residual 58 0.786213 0.013555Total 59 0.807248
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.029871 0.015429 1.936049 0.05774 -0.00101 0.060756 -0.00101 0.060756X Variable -0.72138 0.579086 -1.24572 0.217875 -1.88055 0.437786 -1.88055 0.437786
10 year at 48 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.103308R Square 0.010672Adjusted R -0.01083Standard E 0.106832Observatio 48
ANOVAdf SS MS F Significance F
Regression 1 0.005664 0.005664 0.49623 0.484712Residual 46 0.525001 0.011413Total 47 0.530665
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.019854 0.015774 1.258695 0.214491 -0.0119 0.051605 -0.0119 0.051605X Variable -0.51238 0.727361 -0.70444 0.484712 -1.97648 0.951723 -1.97648 0.951723
129
10 year at 36 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.089575R Square 0.008024Adjusted R -0.02115Standard E 0.114182Observatio 36
ANOVAdf SS MS F Significance F
Regression 1 0.003585 0.003585 0.27501 0.603393Residual 34 0.443278 0.013038Total 35 0.446864
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.021092 0.019582 1.077111 0.289014 -0.0187 0.060888 -0.0187 0.060888X Variable -0.46707 0.890656 -0.52441 0.603393 -2.2771 1.342959 -2.2771 1.342959
130
10 year at 24 observationsSUMMARY OUTPUT
Regression StatisticsMultiple R 0.123706R Square 0.015303Adjusted R -0.02946Standard E 0.090654Observatio 24
ANOVAdf SS MS F Significance F
Regression 1 0.00281 0.00281 0.3419 0.564683Residual 22 0.1808 0.008218Total 23 0.18361
Coefficientsandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.022049 0.019493 1.131169 0.270165 -0.01838 0.062475 -0.01838 0.062475X Variable 0.539081 0.921943 0.584722 0.564683 -1.37291 2.451075 -1.37291 2.451075
Altman Z Score
Altman Z Score Net Working Capital/Total Assets 0.4974 Retained Earnings/Total Assets 0.96021 EBIT/Total Assets 0.6754 Me/BVL 0.05294 Market value equity/Book Value Liab 1.71572 Z Score 3.90167
131
Discounted Dividends
Discounted Dividends Approach WACC(BT) 0.138 Kd 0.07 Ke 0.17
0 1 2 3 4 5 6 7 8 9 10 112006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
DPS (Dividends) $13,447.60 16,137.12$ 18,826.64$ 24,205.68$ 26,895.20$ 29,584.72$ 32,274.24$ 34,963.76$ 37,653.28$ 40,342.80$ 43,032.32$ 45,721.84$
PV Factor 0.8547 0.7305 0.6244 0.5337 0.4561 0.3898 0.3332 0.2848 0.2434 0.2080PV Dividends Year by Year $13,792.41 $13,753.12 $15,113.31 $14,352.62 $13,493.92 $12,581.74 $11,649.76 $10,722.99 $9,819.59 $8,952.33Total PV of Annual Dividends $124,231.80 3964390.95%Continuing (Terminal) Value Perpetuity 415653.091PV of Terminal Value Perpetuity $86,471.38 2759409.05%Estimated Price per Share $3.13 6723800.00%Implied Nov 1, 2007 Price $3.57
Observed Price Per Share $40.47Initial Cost of Equity (You Derive) 17.00%Perpetuity Growth Rate (g) 6.00%Number of Shares 67,238
6% 7% 8% 9%8% $19.83 $36.62 NA NA
10% $9.87 $12.24 $16.97 $31.1612% $6.57 $7.37 $8.57 $10.5815% $4.37 $4.63 $4.97 $5.4217% $3.57 $3.72 $3.90 $4.12
Cost
of
Equi
ty
Perpetuity Growth Rate (g)
Overvalued < 36.42Fair Value +/- 10%Undervalued > 44.52NA
Discounted Free Cash Flows
Free Cash Flows WACC(BT) 0.138 Kd 0.038 Ke 0.17Perp
0 1 2 3 4 5 6 7 8 9 10 112006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Cash From Operations $185,477 $203,098 $222,392 $243,519 $266,654 $291,986 $319,724 $350,098 $383,358 $419,776Cash Provided in Investing Activities -$28,373 -$45,112 -$49,798 -$54,965 -$60,662 -$66,942 -$73,865 -$81,495 -$89,905 -$99,174
Book Value of Debt and Preferred Stock $343,180Annual Free Cash Flow $157,104 $157,986 $172,594 $188,554 $205,992 $225,044 $245,860 $268,603 $293,452 $320,602 $330,220Discount Rate (13.8% WACC) 0.8850 0.7831 0.6931 0.6133 0.5428 0.4803 0.4251 0.3762 0.3329 0.2946PV of Free Cash Flows $139,030 $123,726 $119,616 $115,644 $111,804 $108,093 $104,505 $101,038 $97,686 $94,446Total PV of Annual Free Cash Flows $1,115,588 40.76%Continuing (Terminal) Value Perpetuity 5503674.8PV of Terminal Value Perpetuity $1,621,318 59.24%Value of Firm $2,736,907 100.00% 5% 6% 7% 8% 9%Book Value of Liabilities $343,180 10% $43.77 $51.60 $64.65 $90.76 $169.08Estimated Market Value of Equity $2,393,727 11% $38.84 $44.10 $51.99 $65.14 $91.44Number of Shares 67237.82 12% $35.34 $39.13 $44.43 $52.38 $65.63Estimated Price per Share $35.60 13% $32.74 $35.60 $39.42 $44.76 $52.77Impied Share Price as ofNov 1, 2007 $39.71 14% $30.74 $32.98 $35.87 $39.71 $45.09
Observed Share Price $40.47Initial WACC 14.00%Perpetuity Growth Rate (g) 8.00%
Perpetuity Growth Rate (g)
WAC
C (B
T)
Overvalued < 36.42Fair Value +/- 10%Undervalued > 44.52NA
132
Residual Income
RI check -0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Residual Income WACC(AT) 0.138 Kd 0.07 Ke 0.17Perp
0 1 2 3 4 5 6 7 8 9 10 112006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net Income per Share $2.15 $2.35 $2.57 $2.82 $3.08 $3.38 $3.70 $4.05 $4.43 $4.86Annual Dividend Payout per Share $0.20 $0.24 $0.28 $0.32 $0.36 $0.40 $0.44 $0.48 $0.52 $0.56 $0.60Book Value of Equity per Share $11.21 $13.12 $15.19 $17.44 $19.89 $22.58 $25.52 $28.74 $32.26 $36.14 $40.40
-0.01 -0.01 -0.01 -0.01 -0.02 -0.02 -0.02 -0.02
Actual Net Income $2.15 $2.35 $2.57 $2.82 $3.08 $3.38 $3.70 $4.05 $4.43 $4.86"Normal" (Benchmark) Earnings $1.23 $1.44 $1.67 $1.92 $2.19 $2.48 $2.81 $3.16 $3.55 $3.98Residual Income (Annual) $0.91 $0.91 $0.90 $0.90 $0.90 $0.89 $0.89 $0.89 $0.89 $0.88 $0.88PV Factor 0.9009 0.8116 0.7312 0.6587 0.5935 0.5346 0.4817 0.4339 0.3909 0.3522PV of Annual Residual Income $0.82 $0.74 $0.66 $0.59 $0.53 $0.48 $0.43 $0.39 $0.35 $0.31Total PV of Annual Residual Income $5 14.23%Continuing (Terminal) Value Perpetuity $59PV of Terminal Value Perpetuity $21 55.61%Initial Book Value of Equity $11 30.16%Estimated MVE $37 100.00% 8.5% 9.0% 9.5% 10.0% 12.0%Estimated Price per Share $37.17 11% $31.53 $34.91 $40.55 $51.83 NAImpied Share Price as of Nov 1, 2007 $40.55 12% $21.92 $22.80 $24.02 $25.86 $35.04
13% $16.61 $16.75 $16.93 $17.18 $20.61Observed Share Price $40.47 14% $13.24 $13.13 $12.99 $12.82 $11.29Initial Cost of Equity (You Derive) 11.00% 17% $7.95 $7.73 $7.47 $7.18 $5.44Perpetuity Growth Rate (g) 9.50%Number of Shares 67237.824
Change in Residual Income (0.01) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Growth Rate
Cost
of
Equi
ty
Overvalued < 36.42Fair Value +/- 10%Undervalued > 44.52NA
Abnormal Earnings Growth
AEG Valuation WACC(BT) 0.1387 Kd 0.07 Ke 0.17Perp
0 1 2 3 4 5 6 7 8 9 10 112006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net Income Per Share $1.93 $2.15 $2.35 $2.57 $2.82 $3.08 $3.38 $3.70 $4.05 $4.43 $4.86Annual Dividend Payout Per Share $0.20 $0.24 $0.28 $0.32 $0.36 $0.40 $0.44 $0.48 $0.52 $0.56 $0.60
RI check
-$0.01 -$0.01 -$0.01 -$0.01 -$0.02 -$0.02 -$0.02 -$0.02Annual Income $2.35 $2.57 $2.82 $3.08 $3.38 $3.70 $4.05 $4.43 $4.86Drip Income $0.04 $0.05 $0.05 $0.06 $0.07 $0.07 $0.08 $0.09 $0.10Cumulative Dividend Income $2.39 $2.62 $2.87 $3.15 $3.45 $3.77 $4.13 $4.52 $4.95"Normal" Annual Income (Benchmark) $2.51 $2.75 $3.01 $3.30 $3.61 $3.95 $4.33 $4.74 $5.19Annual AEG -$0.12 -$0.13 -$0.14 -$0.15 -$0.16 -$0.18 -$0.20 -$0.22 -$0.24 -$0.25PV Factor 0.7305 0.6244 0.5337 0.4561 0.3898 0.3332 0.2848 0.2434 0.2080PV AEG (Annual) ($0.0879) ($0.0801) ($0.0739) ($0.0685) ($0.0637) ($0.0595) ($0.0558) ($0.0524) ($0.0494)Total PV of AEG ($0.59)Core Net Income $2.15Core Perpetuity Earnings ($0.57) (2.74)Total Earnings Perpetuity $0.98 Perpetuity Growth Rate (g)Estimated Price (Sept 30th of 2006) $5.79 0% 2% 4% 6% 8%Estimated Price per Share (Sept 30th of 2006) $5.79 8% $43.35 $46.33 $52.27 $70.10 NAImplied Share Price June 1, 2007 $6.60 9% $33.05 $34.26 $36.43 $41.49 $66.82
10% $25.97 $26.34 $26.95 $28.17 $31.83Observed Share Price $40.47 14% $12.37 $12.05 $11.60 $10.93 $9.80Cost of Equity (Ke) 17.00% 17% $8.40 $8.13 $7.78 $7.30 $6.60Perpetuity Growth Rate (g) 8.00%Number of Shares 67237.82
Annual AEG (0.12) (0.13) (0.14) (0.15) (0.16) (0.18) (0.20) (0.22) (0.24)Change in Residual Income (0.01) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Cost
of
Equi
ty (
Ke)
Overvalued < 36.42Fair Value +/- 10%Undervalued > 44.52NA
133
WACC
WACC bt 0.138136587
WACC at 0.130674284
CURRENT LIABILITIES Percent Interest Rate WACDAccounts Payable $111,213 32.41% 5.19% 0.02Accrued Expenses $95,249 27.75% 5.19% 0.01Income Taxes Payable $19,676 5.73% 35.00% 0.02 Total Current Liabilities $226,138LONG-TERM DEBT $72,967 21.26% 5.00% 0.01DEFERRED TAXES AND OTHER LIABILITIES $44,075 12.84% 4.85% 0.01 Total Liabilities $343,180 100.00%Kd 0.07
Ke 0.17
5% for long term debt on loan with CDORWACCBT (343180/1096952).07 + (753772/1096952).17 0.138715WACCAT ((343180/1096952)*.07)*(1-.35) + (753772/1096952)*.17 0.13105
134
References
1.www.menswearhouse.com
SEC Filings
2. www.josabank.com
3. www.brooksbrothers.com
4. www.finance.yahoo.com
5. www.retailindustry.com
6. www.marketwatch.com
7. www.tutor2u.com
8. www.en.wikipedia.org
9. American Apparel and Footwear Association
10. Papelu and Healy
11. Srvbrooks.com
12. St. Louis Fed Fred