In a world where people leave the house in pajama pants and stained t-shirts, it’s a bad time to be a tailor. It’s a worse time to be a suit seller.
Diagnosing a financial statement disease
One big warning sign in Jos. A. Bank Clothiers Inc (NASDAQ:JOSB)’s financial statements is its days sales of inventory measure, which for the most recent trailing twelve months tops 294 days. Using quick math, we discover that Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) isn’t selling its inventory as quickly as it should. The average spot on the suit rack will hold only 1.24 suits per year.
This leads to weak profits in a working capital-intensive retailer. A net margin of 7% during the period means Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) is earning low, low returns on its inventory.
Something has to change for Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) to earn its valuation. It could lever up to finance inventory with other people’s money, but that only exposes it to interest rate risk should rates go higher. Besides, financial engineering isn’t enough to satisfy shareholders who want top and bottom line growth.
Going long on rentals
As fewer people need a daily suit or tuxedo, Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) is looking to tap the rental market for growth. Tuxedo rentals are wildly profitable as a cheap tuxedo can rent for $100 or more per day, several days of the year.
This model should lead to improvements in its asset utilization. Just think, if Jos. A Bank can pay $150 to create a tuxedo, and rent it out for profits of $50 per use just three times a year, it can generate 100% annual returns on all working capital in its tuxedo rental business. Even if it were to rent each tux just one time per year at a profit of $50, it would earn 33% returns on assets in the business, significantly higher than the 8.68% returns it earns on inventory for sale.
A comparable company, The Men’s Wearhouse, Inc. (NYSE:MW), currently earns an 86% gross margin on each tuxedo rental, a fantastic gross margin for an ancillary product. Rentals take up very little sales space, require almost no additional investment (the retail locations are already in place), and are a highly-profitable business line.