Among the biggest winners in Thursday’s early trading are The Men’s Wearhouse (NYSE: MW) and Merge Healthcare (Nasdaq: MRGE).

Suiting up
Fast on the heels of a solid quarterly report last week from men’s clothier Jos. A Bank (NYSE: JOSB) rival, The Men’s Wearhouse released solid quarterly results as well, giving its stock a 15% lift in early trading today. Sales of $662 million in the fiscal second quarter ended in July were roughly in line with estimates, and only modestly higher than a year ago. The anemic growth is mostly due to store closings: On a same-store sales basis, revenue jumped a more impressive 4.4%. Management has also done a solid job of controlling inventory, which invariably leads to fewer discounts and more robust margins. Gross margins rose 120 basis points to 48.4%. 

The Men’s Wearhouse exemplifies the trends underway at many retailers. Customers may still be cautious, but many retailers have become so much more efficient in terms of inventory management and pricing strategies that profit margins remain at fairly impressive levels. This sets the stage for very robust profit gains when foot traffic starts to pick up in an improving economy.

You can already see that kind of leverage in play for The Men’s Wearhouse.  Management now says fiscal (January) 2013 earnings per share (EPS) can reach a range of $2.75 to $2.80 (so look for the current $2.71 EPS consensus to rise). That’s compared with EPS of $2.38 in fiscal 2012. Analysts say EPS can top $3 in fiscal 2014, even as sales are expected to grow less than 5% to around $2.57 billion. 

Merge’s frustration
When a company stumbles for a quarter or two, its shares can get pushed into the doghouse — and stay there for an extended period. There are only a few things management can do to resuscitate shares, and Merge Healthcare has now tried two of them.  The provider of healthcare imaging software first went the insider buying route, which I discussed here.

Shares managed to rally 33% since then as many investors came to see that this this stock was sharply oversold in light of its still-strong presence in many hospital information technology departments.

Yet that bounce back wasn’t good enough for Merge’s management as shares still remained at roughly half of the 52-week high. So in a further bid to regain the lost market value, management has now decided to look for a buyer for the company. News that Merge has hired investment bankers is pushing shares up another 5% this morning.

By my math, this stock is still too cheap, even after today’s gains, as Merge continues to trade at low price/sales multiples in an industry that typically receives more robust multiples. The current $330 million market value equates to just 1.3 times sales.

Although GE (NYSE: GE) and Philips (NYSE: PHG) are key competitors — and unlikely buyers — other health care IT firms such as Cerner (Nasdaq: CERN) and Allscripts (Nasdaq: MDRX) would likely see Merge as a solid strategic fit as hospitals transition to fully-digitized medical records. Cerner is the more likely acquirer simply because it is in far healthier shape than Allscripts right now. This would also be a solid fit for private equity firms, as the company could be taken private and then re-introduced into the IPO market at perhaps a far higher price when Merge’s operating metrics are again trending higher.  

Action to Take –>  Shares of The Men’s Wearhouse pushed past $50 in 2007 when consumer spending was more robust. We may not see a return to those kinds of free-sending days, but the company’s margin structure is now so much more impressive that the company is likely to post net profits that are even more robust than the boom years of the past decade. Shares, now trading at $35, represent a much better value than they did back in 2007, and could make a gradual move back to that 2007 peak. 

Merge Healthcare may actually pull back a bit after today’s gain, as it will likely take several months — if at all — to find a buyer. So don’t be put off if share prices don’t keep building a head of steam in the near-term. Buyout or not, Merge Healthcare looks quite undervalued.