TLRD – Divestor

Tailored Brands (Men’s Warehouse, Moores) does Chapter 11

As predicted earlier, Tailored Brands filed Chapter 11 today. Another retailer bites the dust.

This is not surprising, but when reading the fine print (8-K):

The RSA contemplates a restructuring process that will establish a financially sustainable operating company (“Reorganized Tailored”). The contemplated restructuring process includes (i) the commencement by the Debtors of voluntary cases under chapter 11 of the Bankruptcy Code, (ii) the acquisition of the DIP ABL Facility (as defined below) from the Debtors’ current ABL lenders, (iii) the Consenting Term Loan Lenders agreeing to compromise their prepetition claims in exchange for, among other things, exit debt and 100% of the new common stock of Reorganized Tailored; (iv) the Consenting Term Loan Lenders agreeing to the consensual use of cash collateral; and (v) the implementation of exit financing for Reorganized Tailored (which is described below), each on the terms set forth in the RSA.

The first-lien debt holders will get 100% of the common stock of the reformed entity. The senior bondholders will receive nothing unless if they are thrown a few last second bones (warrants to buy common?) to expedite the restructuring. They last traded at 3 cents on the dollar today.

Tailored Brands: Not looking good

Tailored Brands (NYSE: TLRD), retailing as Moore’s in Canada, filed on Form 8-K that they were not paying their unsecured debtholders:

On July 1, 2020, The Men’s Wearhouse, Inc. (“Men’s Wearhouse”), a subsidiary of Tailored Brands, Inc. (together with Men’s Wearhouse, the “Company”), elected not to make the interest payment due and payable on July 1, 2020 of approximately $6.1 million (the “Interest Payment”) with respect to its 7.00% Senior Notes due 2022 (the “2022 Senior Notes”). Men’s Wearhouse has a 30-day grace period to make the Interest Payment before such non-payment constitutes an “event of default” under the indenture governing the 2022 Senior Notes (the “Indenture”). If an event of default under the Indenture occurs as a result of such non-payment, it would result in a cross-event of default under both the Company’s term loan facility and asset-based revolving credit facility (collectively, the “Credit Facilities”). Men’s Wearhouse has elected to enter into the 30-day grace period with respect to the Interest Payment. During the grace period, Men’s Wearhouse may elect to pay the Interest Payment and thereby remain in compliance with the Indenture.

On July 1, 2020, the Company made its scheduled interest payments required under the Credit Facilities and therefore, as of the date hereof, is current with respect to its interest and principal payment obligations thereunder.

Per their last financial snapshot, and 10-Q, it appears they have approximately $1.2-$1.3 billion in senior debt, coupled with $174 million in unsecured notes, which last traded at 7 cents on the dollar. The company itself, by virtue of drawing its asset-backed facility, has about $200 million in cash (and approx. $90 million in restricted cash) in early June.

It looks like they are engaging in a “Mexican Standoff” strategy that will not go very well for everybody involved – implicitly they are trying to get the unsecured noteholders to concede with the threat that they will go to zero in a Chapter 11 proceeding. The question is what price has been negotiated?

The company, similar to most other retailers, has massive lease liabilities and even if they resolve the unsecured debt situation, still has to face that challenge.

Tailored Brands – not looking too good

The next clothing retailer that stands a good chance of going to Chapter 11 (to restructure what are fairly onerous amounts of outstanding store leases) is Tailored Brands (NYSE: TLRD).

They filed Form 8-K today and the salient highlights are this:

Cash and cash equivalents at the end of the first quarter of 2020 (this would be May 2, 2020) were $244.2 million;

…

As of June 5, 2020, cash and cash equivalents were $201.3 million, excluding $93.5 million of restricted cash.

That’s a burn rate of about $43 million per month, which should be disturbing to most investors, especially since they have a minimum cash maintenance requirement with their lender.

In order to reduce the cash burn, they need to sell inventory and get their stores up and sell product. However, initial data does not look good:

The Company noted that it is too early to determine steady-state comparable store sales for the second quarter but wanted to provide an update on recent performance. For the week ended June 5th, for stores open at least one week, the average comparable sales performance was:

o Men’s Wearhouse down about 65%,
o Jos. A. Bank down about 78%, and
o K&G down about 40%.

Clearly buying suits hasn’t been a priority of the consumer public post-Covid-19.

Ignoring the common stock, which has been exceptionally volatile over the past week (it spiked up to US$2.40 two days ago, and is now closed at $1.24), the corporate debt tells the real story:

This is the July 1, 2022 unsecured debt, with US$173.4 million outstanding. It is structurally behind the majority of the company’s asset-backed loan facility which does not bode well for recovery for the unsecured debt. If you have any inkling that the company will make some sort of financial recovery, however, these bonds are trading at roughly a 100% YTM at present.

A sure sign of Chapter 11 will be if the company decides to withhold interest payments on this debt (we will find out by the end of June), or they could be pulling the plug earlier than that. Who knows, with how Hertz (NYSE: HTZ) has traded after its Chapter 11 filing, it might result in an improvement in the stock price!

A side note – famed “big short” investor Michael Burry took his lumps on the stock last month. At one point he had a 4 million share position (8.3% of the company), with his last shares purchased in March 24, 2020.

I have no positions in TLRD or its debt, and not intending on taking one – they need to chop off half their debt, shed half their leases and this can only come in the form of a restructure within Chapter 11. I made my trade for a few cheap suits after they cut their dividend to zero, and closed it out late last year for a mild gain.

Reversing course on a trade – Tailored Brands

A good part of investing is trying to constantly trying to figure out whether the information that got you into a trade is still applicable or whether it is flat-out incorrect. Unfortunately, the information that you glean from investing without insider information is diffuse and sometimes the decisions made are marginal ones – hence, it is never wise to bet too much of your portfolio on any investment thesis. More certainty of information over your perception of the information that others are pricing into the security allows for a more concentrated bet.

In the instance of Tailored Brands (NYSE: TLRD), it was a combination of diffuse information, hence a relatively modest position. There was a panic in September, coupled with management’s capital allocation decision to cut the dividend to zero, coupled with the actual numbers looking relatively cheap from a valuation perspective (they are a legitimate retail operation, albeit selling product that is facing an overall downtrend for various reasons). September quarterly guidance was very tepid which took the stock down:

* Men’s Wearhouse to be down 3% to 5%
* Jos. A. Bank to be down 2% to 4%
* K&G to be down 2% to 4%
* Moores to be down 4% to 6%.

I got in and out and flipped the stock like a pancake for mild profits. If you’re a large player, it takes a lot of time to scale in and out of stock positions and “pancake flipping” isn’t really an option – you’ll move the price of the stock too much on both ways.

What changed my thesis? One was that Gildan (TSX: GIL) is a precursor fashion company, and they pre-announced in October that things aren’t going too well. Obviously selling things such as t-shirts and underwear is not the equivalent of selling suits and fancy clothing (which involves more marketing and physical presence than raw material), but it was the continuation of the downtrend which is not a good sign. Does this guidance carry forward to other apparel retailers? Does TLRD’s already down-beat guidance already incorporate this, or will things be better than that or worse?

This is ultimately what makes it very difficult to judge as a market participant – what the market is currently betting on. Every piece of information is condensed down into one, and that is price – the assumptions driving the price among the market participants can only be inferred, and sometimes the causes for price changes are for completely hidden reasons (e.g. some hedge fund has to liquidate its entire holdings in a short time period at any price, and does so indiscriminately – these sorts of situations are great to get on the other side of the trades with).

The other reason why I closed out the trade was that I figured is that the psychological exhaustion associated with the suspension of the dividend, coupled with any anticipated benefits of a share buyback had played itself out. What I mean by this is that when a relatively well-known company suspends its dividend, there are many funds out there that invest in the company’s stock strictly on the basis that it has a dividend (any dividend or income-oriented ETF and so forth). These funds are forced to sell the stock within a predefined timeframe because they no longer fit the portfolio policy. Hence, when you see dividend suspensions, investors do not like it because it signals a negative psychology (Can’t pay a dividend anymore? Must mean you can’t make money to pay it, so I should sell!), but also for completely mechanical reasons (funds and ETFs selling due to policy).

Example: Vanguard at August 9, 2019 reported owning 6.8 million shares. Vanguard at October 10, 2019 reported owning 3.4 million shares. Vanguard, of course being the low-cost ETF provider of all sorts of funds running hundreds of billions of dollars of investor capital – pretty clear their income/dividend funds were getting rid of TLRD stock!

It could be the case that suspending the dividend to focus on stock buybacks is rationally the correct decision. Indeed, managements with value-creating characteristics would choose to engage in that, knowing that a dividend suspension would crater the stock price – it would just mean you can buy back more equity at depressed prices. The smartest managements time their annual option grants to coincide with this period, to get the lowest strike price!

Finally, TLRD’s cost of capital has increased considerably over the past month. This has been really noticeable over the past couple weeks where yields have risen on their July 2022 unsecured debt to about 10%, which is the point where the bond markets are getting quite nervous.

I’m guessing unsecured bondholders are not thrilled that some of the capital that is destined to pay them back is going into the hands of the stockholders. This is assuming management is repurchasing shares in lieu of the suspended dividend, but we will not get confirmation of that until the next quarterly report.

If there is a meltdown in TLRD, it will be very fast and spontaneous – similar to what happened to Toys R’ Us – bondholders will not have the opportunity to get out without taking a significant haircut. One big difference, however, is that TLRD still makes some money, so they have that going for them. That amount of money, as top line sales decrease, will be more and more difficult to realize without very diligent cost controls. It is one thing to manage a franchise that is on its way up, and another thing entirely to manage it on the decline – a whole different skillset is required to manage declines gracefully.

TLRD announces their next quarter on December 11, so we will see what happens. Such skittish trading is not the best way of making long-term gains but the cliche of cutting your losers quickly and let your winners run is also overriden by another cliche – when your original investment thesis is broken, get out. There’s always a market somewhere else.

Low price to sales ratios – Tailored Brands

This might sound obvious, but the most amount of income you can generate from a dollar of revenue is one dollar. Eventually taxes will kick in, and that will go down to a net profit margin of around 74%, depending on what province you live in. Then you add in expenses such as salaries, or cost of goods sold, or marketing, and that net margin goes lower. Finally, you have non-operational expenses such as financing which will bring the number even lower.

However, it all starts with revenues – if you can’t bring in anything on the top line, it is guaranteed that you won’t see anything flow to the bottom!

Which is why one of the periodic value screens I typically conduct are companies that have low price to sales ratios.

Most typically they trade that way because they are either in debt/solvency trouble, or in traditionally low margin industries (or both) – if your gross margins are 10%, you better be selling a lot of product in order to cover the other fixed expenses. It is one of the basic premises of my original CMA designation (now merged as CPA) to construct methods to judiciously track the linkage between the top line and the proper allocation of overhead expenses to different divisions.

However, if a company with relatively high top-line sales is not producing good financial results, there are value opportunities if one is lead to believe that management can tweak things to either induce higher profitability or to reduce fixed costs in a manner that will not endanger revenues. These results do not show up in historical financial statements, but when they do appear, the results can be very dramatic.

The most recent example of Francesca’s (Nasdaq: FRAN) fits the definition of dramatic:

FRAN has 3.06 million shares outstanding, so at the end of July they were about a $10 million market capitalization company. I’ll skip the bulk of their corporate history (they were one of those high-flyer retailers that caught tailwinds before they became like the next beanie baby), and their Q1-2020 result (note: their fiscal year ends January) was horrible – $87 million in sales, $9.7 million loss in operations. The trajectory looked like they were going into Chapter 11 (they did have some net cash on the balance sheet but not a ton).

Fast forward to Q2-2020, and a miracle happened – $106 million in sales, $1.4 million income from operations. The stock went haywire as you can see – especially given its low float. It’s very interesting to see when a company with 3 million shares outstanding has a day with 20 million shares traded in volume.

What’s interesting is some very smart people (or insider trading) edged the stock up a few days before the quarterly release. The day after Q2 was announced, the stock doubled and proceeded to wipe out the short sellers (on August 30, 2019 there were 1,163,624 shares that were short!).

Retail fashion is currently an industry that is getting killed because of a confluence of factors. There is the typical Amazon effect – most retailers are in malls, and malls have less traffic these days because people are discovering the experience is a pain in the ass. There are other transient factors, but in general the industry is taking it on the chin.

Reitmans (TSX: RET.A) is a good example. I can get a chart of their stock from October 2016, and place a ruler on my computer screen at a downward 30 degree slope, and it extrapolates to today.

Just because it is cheap doesn’t mean it is a good value – these cases can be classical value traps.

We move onto an interesting case, Tailored Brands:

Tailored Brands initially got on my radar a few months ago because it was on Michael Burry’s 13-F form. Burry is somebody that I have been aware of well before his “Big Short” days, specifically when he wrote on MSN Money at the turn of the millennium (his write-up on American Physician’s Capital was complete genius). Needless to say, I respect his thought process greatly. I was wonder what the heck he was thinking with TLRD, but I guessed the general thesis involved. He eventually explained some of his thinking in a 13-D filing indicating that he has been accumulating shares between $4.30 to $6.00.

Putting a long story short, his letter was that the company still makes money and if management believes in the business, they should scrap the dividend ($36 million a year) and instead buy back shares and increase the EPS materially.

This hype from Burry (who recently went public after a multi-year hiatus with an investment in Gamestop, another retailer, which I do not believe is a good decision because they are truly vulnerable to the Amazon effect) presumably got the short sellers in trouble (in the first week of September, there was an obvious spate of short covering – this is what happens when the stock goes up 40% in a short period of time!). Short interest is VERY high – 23.3 million shares as of August 30. The quarterly report is what got TLRD back down to earth again.

Looking at their financial statements, TLRD does look cheap from a price to sales perspective – annualizing the first 6 months, they sell $62 in revenues for every share outstanding. Operating income is still $91 million for the first half, although definitely going down.

The balance sheet isn’t great, but it is a manageable position – they have a large line of credit that extends out until April 2025 ($884 million outstanding), and a senior note ($229 million) which matures on July 2022. The senior notes trade around 99.5 cents on the dollar with a YTM of 7.2%. Right now the credit market does not look like it is locking out TLRD. Most of this debt acquired in the takeover of Joseph A. Banks (another clothing retailer) which was a total disaster. TLRD also has a large amount of lease liabilities, similar to other retailers, and more visible now due to IFRS 16.

In the last quarterly report, the company also listened to Burry and cut the dividend to zero, and made noise about buying back shares. This was actually a good sign.

When a company reduces its dividend to zero (a brave decision), in addition to the negative psychological sentiment associated with it, there is also the effect of having income funds dump the stock due to the investment policy, not to mention retail people that are deluded into believing the yield statistic they see on the stock is sustainable. There will be the technical effect of a lot of forced selling after the quarter, and I believe we are seeing it presently. The question is how many shares will get force-dumped, and when will the short sellers cover.

It is interesting how at one point the cost to short TLRD went as high as Beyond Meat for a few days – signs that borrowing is getting tougher.

Tailored Brands is mostly associated with the Men’s Warehouse brand, and in Canada it is Moore’s. The question is whether men’s fashions (suits and the like) is still subject to the Amazon steamroller. I would think this segment of retail fashion is less vulnerable than Reitman’s.

So the question is whether management is capable of clotting the bleeding. Guidance for the 3rd quarter was awful (sales down roughly 5%). Operationally management does appear to be getting into a better and more profitable niche (customization), and the question is whether they can pull it off competently.

The risks are pretty obvious. The situation can get worse. The operating income to debt ratio is quite high. Fashion is fickle, and I don’t even want to divulge on this website publicly the last time I bought a suit. That said, I think men’s fashions are less fickle than women’s, but if we get this much-anticipated recession or economic slowdown it will also not help the company’s financial fortunes – a suit is the last thing on the shopping list when one is worried about their employment (note: the Men’s Warehouse still made money during the 2008-2009 economic crisis).

That said, there was a pretty good reason why this thing was trading at $24/share a year ago. It could easily get there again – a couple quarterly reports with stabilization will do this. They set the bar very low for Q3. The CEO also put up $72k of his money into the stock after the quarterly report, which is better than nothing.

I’m buying shares in the low 4’s. It will not be a large position, but my price target is $20/share.

Normally I do not like these sorts of companies for a few reasons. One is that there are too many eyeballs tracking this, especially now that Burry has made his 13-D filing public. I am not typically a “follow Buffett” type of investor – usually when I read about something from another source, I use it as an exclusionary criterion. However, there is a good chance the market sentiment is so negative that the chances of a less negative outcome are a lot better than the consensus.

If it works out, I’ll buy a cheap suit.