Jos. A. Bank: Clearance Sale

Dare you to find a stock more unloved than that of suit seller Jos. A. Bank Clothiers. How do we know so many investors hate the apparel retailer? Because 93% of the Jos. A. Bank shares available to investors were sold short as of April 30. For comparison, only 16% of rival Men's Wearhouse shares had been shorted.

Short selling is a way to make money on a falling share price. Short sellers borrow the stock from another investor, then sell it in the hope of buying it back in the future at a lower price and then returning the borrowed shares.

Investors are uneasy with Bank because the Hampstead, Md., retailer shuns Wall Street. In January, the company (symbol JOSB) stopped reporting monthly same-store sales, which track sales at stores that have been open for a year or more. Same-store sales give investors a clearer sense of how the retailer is performing because the measure excludes revenue from newly opened locations. Bank also skips the customary question-and-answer sessions with analysts on its quarterly conference calls and doesn't make earnings projections.

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But look past Bank's unfortunate cone of silence and you'll see a high-end retailer in better financial shape than its battered stock would indicate. The company has grown rapidly under chief executive Robert Wildrick, who took control of the 103-year-old retailer in 1999.

Sales have tripled from $194 million in fiscal 1999 to $604 million in fiscal 2007, which ended last January 31. Net profit has gone up every year, from $3 million in 1999 to $50 million in 2007. In 1999, Bank had less than 100 stores in the U.S. Now it has more than 420 locations.

Short sellers are quick to trot out the financial skeletons in Jos. A. Bank's closet: As of last count, the company had 344 days of inventory (or $207 million), more than twice that of Men's Wearhouse. Bank used a hinky method of calculating same-store sales until 2005. After the company changed its accounting practices, same-store sales growth decelerated.

A class-action lawsuit brought by shareholders angered by a fall in the share price after a 2006 earnings miss could reveal more financial shenanigans, the shorts say. And maxed-out consumers will buy fewer suits and accessories in a weak economy.

Most of these concerns are overblown, says Vitaliy Katsenelson, research director at Investment Management Associates, a Denver money manager. Apparel retailers always run a risk that the clothing they hold in inventory will go out of fashion. But Bank's conservative mix of men's shirts, slacks and suits are timeless, Katsenelson says, because men's styles change at a glacial pace. Instead of indicating an inability to move merchandise or creating a drag on future results, the inventory build-up is part of the deliberate strategy the company's management has communicated to investors since 2001, says Katsenelson, who personally holds the stock.

Indeed, Bank management argues that a large inventory means a wider selection for customers and aids Bank's expansion plans because the company has the clothes with which to stock new stores. (Bank plans to add 38 to 48 stores in fiscal 2008, which ends next January 31.) Moreover, the stash of suits has lately insulated Bank from rising tailoring costs in Asia, Wildrick told investors during an April 15 conference call during which he did not take questions.

Other than a large inventory, Bank's balance sheet is as pristine as starched white shirt. The company has no debt and holds $83 million in cash. That money will help the company weather an economic downturn and makes Bank tempting as a buyout candidate, Katsenelson says.

Even in a dismal retail environment, Bank's high-end customers, who have an average household income of more than $100,000, will continue to shop. "Its customers did not use home-equity loans to buy dress shirts or suits," Katsenelson says. He argues that men who need suits for work will buy them regardless of the economy. His proof: Sales and earnings at Jos. A. Bank grew by single-digits in last recession.

As Bank shops mature, same-store sales will increase, Katsenelson says. A new store generates an average of $800,000 per year in sales and takes about five years to reach its full potential of $1.6 million per year. More than half of the retailer's stores are less than five years old. While a weak economy may mute progress in the short run, the company's performance at each store should steadily progress, Katsenelson says.

And Bank has plenty of room for improvement. At last report, the company generated $329 in annual sales per square foot, compared with $478 at Men's Wearhouse, whose stores are older, on average. "The difference is due to store immaturity," Katsenelson says.

Until recently, selling short Bank's shares had been a profitable trade. The stock plunged 56% between June 12 and March 31. Since then, the shares, which closed at $25.77 on May 23, have gained 26%.

The stock still looks cheap. It trades for nine times the $2.84 per share that analysts estimate the company will earn in the fiscal year that ends next January 31. Shares of Men's Wearhouse (MW) trade at 11 times earnings. Katsenelson thinks Jos. A. Bank shares are worth at least $37, which would give the stock a P/E ratio of 13.