Two months ago, I was lukewarmly bullish on buying shares of The Container Store's (NYSE: TCS ) stock. Today, we can remove the "lukewarmly" part. Before I explain why, you can read the details of The Container Store's business model and my previous analysis by clicking here.
Two months isn't a long time, but two recent developments have helped me update my thinking:
- The Container Store reported its first quarterly earnings since its November 2013 IPO.
- Co-founder and CEO Kip Tindell sat down with a colleague and me for an interview at The Motley Fool headquarters.
When I looked in on The Container Store previously, I saw a small retail concept -- 63 stores at the time -- with lots of room for growth -- they're projecting 300 stores in the U.S. I loved the lack of competition in its organizational niche, its determined focus on that niche, its long-term holistic strategy that seeks to find win-win-win-win situations for employees, suppliers, customers, and shareholders, and its ability to charge huge mark-ups.
However, three worries tempered my enthusiasm:
- Despite leading the league in gross margins, The Container Store hasn't been profitable, largely due to the tremendous amount of money it spends on its people costs.
- The Container Store touts its "employee-first culture," but its Glassdoor ratings were only decent on both an absolute and relative basis. Only 57% of the employees that weighed in anonymously would recommend it to a friend. Across the different ratings categories, The Container Store consistently rated higher than Wal-Mart, Crate & Barrel, and Bed Bath & Beyond, but lower than Target and Amazon.
- The Container Store's debt load is quite high.
I'm worried about each of these less today than I was last time. Let's hit them in order.
The people costs
The Container Store paying and training its people very well versus its retail competitors is part of what enables it to achieve a great store experience that enables higher margins and continuously improving same-store sales growth.
I'm more than fine with that. My fear has been that the people costs won't come down as The Container Store expands. However, on the conference call, the management team noted that scale will indeed help on the people side, as reflected in selling, general, and administrative costs potentially falling from 48% of sales to somewhere in the mid-40s. In addition, there's also room for gross margins to increase from its already impressive 59% to the low 60s. Combined, we're talking something like five percentage points of margin in the near to medium term, which would move The Container Store from its roughly breakeven bottom line firmly into profitable territory.
In addition, during our interview, Tindell flashed a bit of entrepreneurial competitiveness. Like Whole Foods, The Container Store is part of the Conscious Capitalism movement. Conscious Capitalism looks for those win-win-win-win situations I mentioned earlier. Kip made the point that companies like his need to show strong profitability to prove to the doubters that Conscious Capitalism works. As a shareholder myself, I was looking for that acknowledgement of the need for balance between the interests of employees and shareholders.
The employee ratings
We asked Tindell about those Glassdoor ratings and his response was in line with what I was suspecting. There's self-selection in who fills out the ratings, and sometimes, pockets of disaffected folks can unfairly influence the ratings. Any company could claim the same, but I believe it could be at work here because Tindell freely admits that The Container Store's culture is so strong that those who don't buy in tend to get frustrated and leave.
As another data point in support, he pointed to The Container Store's 15th straight year of being named on Fortune magazine's list of 100 best companies to work for in America. As a company, you do have to apply, but rather than self-selecting, the employees surveyed are chosen randomly.
I'll throw in a subjective test, as well. In talking to Kip Tindell and Audrey Robertson (VP of Cultural Programs, Community Relations & Social Media) in person, I got a sense that these were genuine people who believed in their mission, and cared about their fellow employees. Put more strongly, if my passion were boxes instead of financials, I'd be tempted to apply for a job at their headquarters myself.
The debt load
The Container Store's debt-to-equity ratio is at 178%. That's a lot, and it worries me.
The debt load makes sense given its history, though. Due to a transaction in 2007, The Container Store is still benevolently controlled by a private equity company. In private equity circles, this level of debt isn't uncommon.
Tindell noted in the conference call: "Prior to that, we had little or no debt in our history. We are determined to reduce our debt modestly and steadily, while simultaneously achieving sector-leading growth targets."
I still worry about the current level of debt, but I'm comforted that the plan is to indeed reduce it in time. Scale will also help reduce the debt load on a percentage basis.
Other reasons for optimism
In addition to the assuagement of my fears on those three concerns, here are a few more quick-hit items that are making me more bullish:
- The Container Store was previously estimating annual square-footage growth of at least 10% a year. It's now targeting a 12% minimum.
- Part of the reason The Container Store is so confident in its growth prospects can be explained by this line from the conference call: "Until fairly recently, we thought we had to primarily open stores in only the biggest metropolitan areas, areas like New York, Chicago, Los Angeles. But we've been thrilled to discover that when we open stores in more mid-sized markets with approximately 1.5 million GMA, Greater Metropolitan Area, places like Indianapolis, Raleigh, Charlotte, Nashville these stores are extremely successful." Bears on The Container Store have been worried about potential performance in these smaller markets. However, The Container Store has seen enough success in these places that these mid-sized markets are its new near-term growth focus. To give you an idea of the potential, there are 21 GMAs with more than 2.5 million people (Denver and larger), but there are 31 mid-sized GMAs with populations between one and 2.5 million people (that range spans Grand Rapids, Michigan to Pittsburgh in size).
- An interesting point from the conference call: The Container Store's best-selling products are also its highest-margin products. The prime example is its elfa closet products.
- The Container Store is now beginning to actively go after business-to-business sales: "residential and commercial real estate contractors, developers, hotels, hostels, schools, educational facilities and architects." That could be a nice kicker to its traditional consumer business.
And then, finally, we have a better price than we did.
Based on my prior analysis, I decided to buy a small amount of The Container Store's stock in the real-money portfolio I manage for The Motley Fool, and also in my personal account. I concluded my article with this caveat:
Given its status as a young, newly public company with a large debt load, The Container Store's stock may be volatile, and we could see much lower prices than today's share prices. Honestly, I kinda hope that happens. If we do see better buying prices, I may not be able to contain myself.
Well, I got my semi-wish. Shares fell about 15%-20%, and are now in the high $20s per share. I still think it could go lower, but this lower stock price combined with all the positive trends I'm seeing at The Container Store means I'll be buying a little more in both my Motley Fool real-money portfolio, and in my personal account.
Two months has brought us a better price and a story that continues to improve... I can't wait to see what two decades brings us.