Everyone loves a good IPO, especially the initial shareholders who took the company in question public. This dynamic was highlighted earlier today when The Container Store Group (NYSE: TCS ) rose more than 100% from its opening price of $17.50 per share. The company operates as the "leading specialty retailer of storage and organization products in the United States", or, worded more simplistically, it's a company that sells boxes for storage purposes. In light of the significant increase in market value created today, I think it only appropriate that the question of the company's affordability is brought into question. After such a large rise, is The Container Store undervalued or is there little to no hope of achieving out-sized returns by buying now?
Since The Container Store doesn't have any direct competitors that are publicly traded, I decided to compare it to other specialty retail stores in an attempt to gauge how it's priced compared to similar retailers. The companies I am comparing it to include Lumber Liquidators Holdings (NYSE: LL ) , a provider of hardwood flooring, Restoration Hardware Holdings (NYSE: RH ) , a provider of home furnishings, and Tile Shop Holdings (NASDAQ: TTS ) , a provider of stone tiles.
Looking at each entity, I decided to compare them to one another on a price/sales ratio. Although I am usually hesitant to use price/sales because it doesn't actually take into consideration the profitability of each entity, it's generalness should serve as a decent indicator given the different cost structures of each that would make a price/earnings analysis somewhat unfair. This is also useful as The Container Store Group has not been profitable on a GAAP basis in recent years.
Using each company's current price and comparing it to its sales as of its most recent fiscal year, we arrive at the graph below:
(table made by author with data from MSN Money)
According to the chart above, we can actually see that the company is trading at a pretty cheap multiple of 2012 sales compared to its peers. While its price is in line with Restoration Hardware at 2.26 times sales, it's trading far lower than the 3.81 times sales that Lumber Liquidators is and the high 6.57 times sales that Tile Shop is trading for.
But is the picture really all that clear?
Based on the company's low price/sales ratio, there's no denying that it is relatively cheap when placed next to its peers. However, just because it is relatively cheap doesn't mean that there is free money on the table. While analyzing The Container Store's registration statements, I discovered some disconcerting facts about it that may indicate the company isn't all that impressive.
For starters, while the company has seen its revenue increase by around 11.5% per annum recently, it has seen net losses in each of the past three years. Fortunately for shareholders, the company has been getting closer and closer to break-even, as evidenced by a loss of only $130,000 for its 2012 fiscal year from $706.8 million in revenue. This stands in stark contrast to the company's net loss of $45.1 million from 2010. But, if you look at the primary driver of increased profitability, you will find that essentially all of the change in the company's bottom line has come about thanks to lower impairment charges as opposed to something more favorable like cost containment initiatives.
The reason why this isn't impressive is twofold. First, unlike cost containment, impairments of the nature that The Container Store exhibits don't have any impact on company's ability to generate cash. Second, impairments are something that can't be easily estimated. As opposed to seeing a simple increase or decrease in costs (assuming you hold your method for accounting for inventory constant), impairments are estimates by management that can be easily manipulated to suit whatever they think is best if there isn't a strong level of internal control within a company.
In addition to the company's earnings problem, it also has a significant amount of debt relative to equity at a ratio of 2.66. What this means is that, for every dollar of assets after subtracting all liabilities, the company has $2.66 worth of long-term debt. Although this doesn't necessarily imply that the company will be going out of business anytime soon, it serves as a warning signal for shareholders. To make matters worse, $90 million (or 24.9%) of the company's $361.3 million in debt outstanding was issued so that investors could be paid a handsome distribution in April of this year. I don't know about you, but I'm not fond of the idea of a company assuming debt so that it can reward previous owners in this manner because it feels too much like the company is being used as a piggy bank.
On top of all this is the fact that, instead of using the $230.6 million in proceeds from its IPO to increase its store count, the company plans on using it to reward owners of its 12% cumulative preferred stock, which has a significant amount of dividends in arrears. Again, I am not fond of giving such a large amount of cash back to shareholders because it could be used, instead, to grow the business, but given the 12% rate and its cumulative nature, I believe it's not a terrible investment decision.
According to the calculations above, it appears that The Container Store is relatively attractive on a price/sales ratio. However, the fact that the company has a large amount of debt, and that some of that debt was incurred for the sake of paying shareholders (and that the IPO proceeds won't be used for growth), appears dubious to me. As such, I don't plan on investing in the company in the foreseeable future, but I also don't think that it's a terrible investment candidate either. As always, Foolish investors should do their own research before making any investment decisions.
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