All dressed up

In fact, there are numerous explanations for the dearth of investor enthusiasm.

Canadian Business magazine
November 26, 2001

All dressed up
Mark’s Work Wearhouse may get bought—or go private
Zena Olijnyk

Garth Mitchell, chief executive of Mark’s Work Wearhouse Ltd. (TSE: MWW), apologizes for the fact that he’s not wearing a suit, but makes it clear he rarely ever puts one on, for most business meetings. “Except for maybe when I’m meeting with bankers,” says the head of the Calgary-based casual and workplace clothing retailer. True to his “business casual” style, he hasn’t brought a suit on this November trip to Toronto, dashing the hopes of a Canadian Business photographer sent to take his picture. He wants to shoot Mitchell in full business attire—except for a pair of work boots on his feet (a nod to Mark’s position as the No. 1 seller of such footwear in Canada). Photographer and subject end up working things out during a shoot in Mitchell’s hotel room, playing up the CEO’s relaxed, easygoing manner. The boots stay on.

However, Mitchell might want to have a suit pressed and ready for action, especially since shares of Mark’s have recently gained some momentum and the company appears to be in play. In early October, Mark’s issued a news release saying it had received “an expression of interest for the purchase of the company” from an unnamed party. Later that month, it announced it had formed a committee of independent directors, which had retained CIBC World Markets as financial advisers to meet with the suitors and, undoubtedly, to see if any other potential buyers are out there. “We’re a public company; we have to respond,” says Mitchell, citing the usual “fiduciary duty to shareholders.” Mark’s shares are now trading in the $3.20 range, more than double a 52-week low of $1.55. The last time Mark’s, which has no controlling shareholder, was the subject of a takeover bid in 1997, its shares soared well past $4.

But being a publicly traded, small-cap specialty retailer in Canada has had its share of frustrations, Mitchell admits. The company, with 321 stores under the banners of Mark’s Work Wearhouse, Work World and Dockers, saw its annual sales jump to almost $500 million from $300 million between fiscal 1997 and fiscal 2001 (which ended this past January). During the same period, earnings before interest, taxes, depreciation and amortization (EBITDA) doubled, to $31 million, over the same period. And despite some softening in the summer and a dismal September, the company’s sales for the 39 weeks ended Oct. 27 were $324 million, 5.8% higher than they were for the same period last year. October was a surprisingly good month, with overall sales up 10.6%. Even with the recent lift in share price, however, Mitchell complains the company’s stock has been chronically undervalued by investors—a situation not likely to change much anytime soon.

Mark’s shares trade at a price-to-earnings multiple in the 10 to 12 range, based on forecast earnings of 26¢ a share for the fiscal year ending January 2002 and an analyst’s estimate of 35¢ a share the following year. Mitchell says retailers of similar size in the US trade at much higher multiples, mainly because they’re perceived as having more growth potential. “We ourselves don’t have any frustration with our business growth,” says Mitchell, adding the company is aiming for 450 stores and sales of $800 million within a few years. “We have frustration in the perceived value of our company by the investment community.”

In fact, there are numerous explanations for the dearth of investor enthusiasm. First of all, the lack of liquidity that comes with any small-cap stock makes it hard for institutional investors with large holdings to trade the security. Second, Mark’s business is seasonal; 40% of sales come in the all-important fourth quarter, when warm winter weather can wreak havoc. Third, it took a long time to get the franchise-based Work World banner, acquired in 1996, to contribute to profits (it only started doing so last year). Mark’s also got involved in a couple of “retail research and development” ventures that have either failed or have yet to prove themselves. There’s also the matter of bottom-line earnings, which haven’t grown as much as investors expected—they’ve been hovering between 21¢ and 30¢ a share since fiscal 1998. And finally, although Mark’s is one of only a few companies that provide annual earnings forecasts, it has had to revise them several times over the years to reflect everything from unpredictable weather to a slackening economy.

Richard Howson, executive vice-president of Howson Tattersall Investment Counsel Ltd. and an institutional holder of Mark’s shares, points out that while management “has done a good job” with the company’s core business, especially Mark’s Work Wearhouse, “they haven’t had great success with their R&D,” which would take them in a new growth direction. An expensive test run of two Mark’s stores in the US lasted three years before the company pulled out. “In investors’ eyes, expansion in the US was a big growth-potential area, so their expectations weren’t fulfilled,” says Howson. Meanwhile, eight mall-based Dockers stores the company has been operating in Canada (under an agreement with brand owner Levi
Strauss & Co.) are not yet profitable. “The brand name is well-known,” says Howson. “But they have to invent the store.” Mitchell himself acknowledges they are working at improving the product mix.

Keith Howlett, an analyst with Research Capital Corp., estimates Mark’s will earn 25¢ a share this year and 35¢ a share next year. He recently upped his 12-month target price on the stock to $3.90 from $3, reflecting the possibility of a takeover—though he figures any buyer is not likely willing to pay more than $4 a share. Among the names of strategic buyers being bandied about are the usual suspects of Canadian retailers: Reitmans (Canada) Ltd., La Senza Corp. and Grafton-Fraser Inc. American Eagle Outfitters Inc., which recently opened stores in Canada, is one US retailer that has come up in speculation. But Howlett and other retail watchers suggest a financial player could be involved, hoping to pick up Mark’s relatively cheaply to flip later or to forge a strategic partnership with management and take the company private. “If this is all the market wants to pay, if investors assume the worst about any growth attempt you might want to make, you might as well take it private,” Howlett says. And you can bet Garth Mitchell is probably thinking the very same thing.

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