Friday, August 04, 2006

Being Contrarian With Jos. A. Bank

By Vitaliy Katsenelson
www.minyanville.com

Jos. A. Bank (JOSB) is up close to 6% after reporting truly unbelievable sales numbers for July: same store sales were up 16% and total sales were up 28%. July's performance has validated my view on the stock that you are about to read.

What does it really mean “being contrarian?” Doing the opposite of what everybody else is doing, all the time? What if you agree with what everybody else is doing? Should you disagree for the sake of being contrarian?

“Being contrarian” means being able to think and act independently of the crowd and not be swayed by the crowd thinking. It means to stay on your own autonomous thinking track, independently of the direction the crowd is taking, even if it requires going against the crowd. It means not accepting (though respecting) the market’s wisdom unconditionally, but attempting to develop an opinion of your own.

Yogi Berra’s saying “In theory there is no difference between theory and practice. In practice there is,” could not be more true when it comes to contrarian investing. In theory it is easy to be able to think and act independently; however, in practice it becomes a very lonely and trying experience. Emotions that we don’t experience in the theoretical state overcome us in "the in-the-practice-state."

Investing in Jos. A. Banks requires the investor to be a contrarian. Wall Street hates the stock for sending share price from the mid 40s in April 2006 to the mid 20s. The stock is trading at a pitiful 12 times forward earnings. The stock has been slaughtered as Wall Street did not care for the earnings miss in the first quarter coupled with higher inventories.

At this price, the market expects no growth from the company, but the market could not be more wrong. Here is why:

In December of 2005, JOSB delivered 20% same store sales; management has likely expected this trend to continue and has built up a significant amount of fall inventory. However, weather was not on the company’s side, the spring ended up being warmer. The 20% same store sales comps of December did not come through in the following months and that, coupled with warmer springs, sent management on a fall close discounting spree. Management admitted that it was too aggressive in discounting fall merchandise, with the benefit of hindsight it did not have to do that.

It is hard to tell what the next quarter will look like, but that would be focusing on the trees in the forest and not on the forest. However, the future (the forest) appears to be bright for this company. I recognize that managing business involves making decisions under uncertainty. In the first quarter, management made a mistake, I believe that mistake will have little consequence in the long-term fundamental picture of JOSB.

Inventory is Not An Issue

Retailers live and die by their inventory; it is the lifeblood of their retailing business. Too little inventory means the company doesn’t have enough goods to sell, too much inventory means the company has to heavily discount merchandise in order to clear the inventory. So here is the perceived bad news about JOSB – its inventory days have almost doubled over the last six years from 173 days to 334 days. It is twice the amount of its most comparable competitor, Men’s Warehouse (MW) whose inventory days have stayed in a very stable range of 153-169 days over the same time frame. That is just bad, isn’t it? On the surface, inventory numbers look terrible.

Over the last six years since the new management team has taken the reins of Joseph A. Banks, it has intentionally increased inventories per store. Why am I not worried about high inventory levels? Not all inventories are created equal. Inventory increases at a grocery retailer, like Kroger (KG) may lead to higher spoilage and thus lower profitability. Teen apparel retailers, like American Eagle Outfitters (AEOS) and Abercrombie and Fitch (ANF) need to have a fairly high inventory turnover, as teen preferences for the size and location of holes in their jeans could change with Britney Spears' new CD. However, when it comes to men’s apparel, the men’s tastes rivals the speed of the ice age. Blue shirts and stripe suits have been in fashion as long as...well, forever.

Instead of looking at JOSB's inventory as a risky, unstable assets which may have to be discounted by the retailer to clear the shelves (which is usually is the case for other retailers), one should look at it as an investment in long term assets, not unlike investment in store improvements. Though increasing inventory per store is counter intuitive for retailers that strive to achieve Wal-Mart (WMT)-like inventory efficiency, JOSB customers come to the stores only once or twice a year. The company wants to...

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