Jos. A Bank Is a Patient Joe

By Vitaliy Katsenelson, CFA

August 31st, 2006 - The Motley Fool

Investing isn't for the faint of heart. A Foolish investor must be strong enough to change his or her mind when a stock's underlying facts change -- or hang on tight, even in the face of a share-price decline, when they don't. I wrote a very favorable article about Jos. A. Bank (Nasdaq: JOSB) about a month ago, and I wouldn't change a single line in that article, despite news that the retailer's same-store sales for August fell 6.1%.

Monthly same-store sales numbers are just too random to make good predictors of future results. And Jos. A Bank's most recent sales faced numerous obstacles:

• They had to top last month's 15.9% same-store sales increase. The company's average July/August sales are still up 4.9%, and year-to-date same-store sales are still running at a very impressive 5.7% clip. Note that catalog and Internet sales (about 10% of total sales ) were up 17.4% in August.
• They faced similarly tough comparisons with the year-ago quarter's 12.9% same-store sales increase.
• Finally, they relied upon uneven promotional activity. Jos. A. Bank's same-store sales were always volatile, largely because of its legacy marketing positioning. Under previous management, the company mailed promotional coupons to target male shoppers; store prices were inflated to compensate for these coupons. This kind of of promotion-driven marketing causes same-store sales to ebb and flow.

The current management team is gradually trying to steer the company away from coupons and toward brand-building via TV advertising instead. But old habits die hard; male shoppers in established Jos. A. Bank markets have grown accustomed to waiting for coupons before shopping at the store, so the company must still rely heavily upon coupons to bring them in.

Invasion of the increasing inventoryWhile all these points may help explain Jos. A. Bank's recent difficulty with same-store sales, they're irrelevant to any analysis of the overall company. This is not a sales story; the company has demonstrated a healthy ability to grow sales. This isn't even really a profit-margin story; with the exception of last quarter, the company's profit margins have been rising since 2001.

No, Jos. A. Bank is an inventory story. The stock has fallen from its mid-$40s highs because Wall Street doesn't trust a retailer whose inventory has been on the rise for the last five years. The distrust makes a lot of sense to me, since retailers live and die by inventory -- but not all inventory increases are created equal. If inventory days were to rise for American Eagle Outfitters (Nasdaq: AEOS) or Abercrombie & Fitch (NYSE: ANF), I'd be very concerned, since teenagers' love affair with hole-filled jeans fluctuates as quickly as the fashion trends spotted on YouTube or MTV. But casual and not-so-casual men's fashions move at a more glacial pace. White and pinstripe shirts have been in fashion since ... frankly, I can't count that far back.

Out-of-control inventory increases are simply scary, an indication that customers don't want to buy the company's merchandise. But again, that's not the case here. In conference call after conference call, Jos. A. Bank management has stated its intent to increase inventories at its stores. Why? The company found it was turning customers away because it didn't have enough of the right sizes. By increasing size selection in its stores, Jos. A. Bank was able to generate higher sales. It's just that simple.

Rising inventories are a cash flow hog, but Jos. A. Bank still has enough cash left over to fully cover its explosive growth. Despite rising inventories, its return on capital has been increasing since 2001, exceeding the return on capital of Men's Warehouse (NYSE: MW). The higher-inventory strategy has worked for Jos. A. Bank, and I believe it will keep working.

Tailored for successHow much inventory is enough? Management has indicated that the end of inventory increases is in sight. Once the market becomes comfortable with Jos. A. Bank's inventories once more, the stock should find a renewed Wall Street following. In my analysis, Jos. A. Bank should earn about $5 a share in 2009 -- perhaps a dollar or so less if the economy slows down. At today's price, I've got more than enough of a margin of safety to remain patient about this stock.

Fool contributor Vitaliy Katsenelson is a vice president and portfolio manager with Investment Management Associates, and he teaches practical equity analysis and portfolio management at the University of Colorado at Denver's Graduate School of Business. He and his company own shares of Jos. A. Bank. The Motley Fool has a disclosure policy.Vitaliy N. Katsenelson, CFA This article is written for educational purposes only. It is not intended as a recommendation (or advice) to buy or sell securities. Author and/or his employer may have a position in the securities discussed in this article. Security positions may change at any time.