The Container Store Presents a Dilemma for Investors

After a weak first quarter and corresponding plunge in share price, is The Container Store a buy, hold, or sell?

Jul 16, 2014 at 9:00AM

The Container Store (NYSE:TCS) CEO Kip Tindell received a lot of attention following his comment that America is in a "retail funk." Tindell made this statement in the context of explaining that The Container Store's weak first-quarter results, highlighted by a 0.8% decline in comparable-store sales, did not entirely result from weather. While many bears argue that competition caused this performance, retailers across the country are feeling similar effects; a variety of specialty retailers from Lumber Liquidators to PetSmart (NASDAQ:PETM) have struggled with declining comparable-store sales. Even Wal-Mart  and Target have reported declining comps.

While The Container Store is clearly not alone with its disappointing results, investors need to take a moment to reassess the investment thesis that supported the company's rise in share price following its IPO last year. 

What to make of the growth thesis
The decline in comparable-store sales at The Container Store is certainly cause for concern and needs monitoring throughout 2014; weak results for the duration of 2014 would be a significant red flag for investors who were counting on consistent growth touted during the IPO process.

However, the revenue growth scenario is not entirely dire. In the first quarter, The Container Store grew its revenue 8.6% thanks to continued growth in the number of Container Store locations. With three store openings in the first quarter and five more scheduled for the company's current fiscal year, The Container Store remains on track to add 12% to its total square footage this year.

With a store count of just 66 locations, The Container Store is just beginning to build out a national footprint. Looking further into the future, the market's estimate that The Container Store can grow by almost 500% to reach 300 locations remains intact. 

Monitoring the competition
Many of the products sold by The Container Store compare with items available at retailers such as Bed Bath & Beyond (NASDAQ:BBBY) and (NASDAQ:AMZN). While Bed Bath & Beyond managed to eke out comparable-store sales growth of 0.4%, there is no indication that traffic from The Container Store is opting to visit brick-and-mortar competition instead. remains a formidable competitor and will likely continue to gain share in The Container Store's primary market of home organization as it increases variety, competes on price, and provides the convenience of fast and free shipping. After all, why wouldn't a customer who is already visiting to buy a book go ahead and buy the same OXO home organization product available for purchase at The Container Store? Shipping is fast and free, and the transaction is more convenient than visiting either a bricks-and-mortar Container Store or paying for shipping that starts at $8.95.

Screen Shot
Example of an elfa customized storage solution. Source:

The Container Store has two key defenses against both and Bed Bath & Beyond. First, the company has more high-quality products, many of which are made in the USA. Second, there is a service element that comes with the idea of providing home organization "solutions" with differentiation from the competition. In-store advice from knowledgeable employees, ATHOME consultations by organization experts, and elfa design and installation services all provide customized solutions that the competition does not.

Focusing on services has been a popular way for bricks-and-mortar stores to combat online competition. This is true not only for The Container Store, but also for a number of other specialty retailers. For example, may be able to provide competitive prices on dog food, but there is no way to match the grooming and boarding services offered by PetSmart within the current e-commerce format

Leadership remains critical
Company leadership and philosophy remains a critical aspect of the investment thesis for The Container Store. CEO Kip Tindell remains consistent in his commitment to conscious capitalism, management remains focused on an employee-first culture that continues to place on Fortune's list of the "100 Best Companies to Work For," and management consistently tests new ways to enhance the value proposition for customers. Recently, the roll-out of ATHOME, the POP! loyalty program, and the announcement that the company will roll out a high-end closet solution clearly indicated management's commitment to staying ahead of the competition.

Valuation considerations
Following the IPO last year, there was some anxiety regarding The Container Store's premium valuation on a price-to-sales ratio basis. Following recent declines in share price, the company's trailing price-to-sales ratio has improved as noted below:

 TTM P/S Ratio
November 30, 2013
TTM P/S Ratio
July 12, 2014
TCS 2.3 1.5
BBBY 1.4 1.0
AMZN 2.4 1.9

Source: Yahoo! Finance 

While the price-to-sales ratio has declined for each of these companies, The Container Store saw the largest drop in its multiple. Despite this improved valuation, The Container Store trades at 35 times forward earnings, which is triple the earnings multiple of Bed Bath & Beyond. This is an important reminder that shares of The Container Store still have significant growth assumptions already priced into their valuation.

Capital structure limitations
The Container Store's capital structure may constrain its ability to grow going forward. During the most recent quarter, the company reported that it had $8.6 million in cash and $60.2 million in borrowing capacity compared to $361.6 million in debt. The current debt level is not particularly concerning, but the addition of more debt or the issuance of new shares to fund growth could be cause for concern for shareholders who have been on a roller-coaster ride since the IPO:

TCS Chart

TCS data by YCharts

Long-term investing focus
Investors have every reason to be upset with the performance of The Container Store in 2014; its shares have declined 45% in a solid bull market. However, investors who have a long-term focus must try to separate the short-term price movements from the long-term investment thesis. For investors who have a long-term perspective, the pertinent question is: "what has changed?"

The answer is that the larger retail environment has been softer than expected in 2014. Some of this is due to weather, but a lot has to do with the economic recovery not perfectly correlating with consumer spending habits. The result for The Container Store has been disappointing comparable-store sales results; whether any portion of these struggles have a root in company-specific weakness is not determinable at this time. 

This uncertainty is ultimately the root cause of recent declines in The Container Store's share price. For long-term investors who believe that the economy drove its recent struggles, its shares are available at a much more compelling valuation than they were six months ago. Risk remains with this innovative small-cap retailer, but its growth potential and improved valuation make a compelling argument for initiating or adding to a position at current prices. 

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Brian Shaw owns shares of, PetSmart, and The Container Store Group. The Motley Fool recommends, Bed Bath & Beyond, Lumber Liquidators, PetSmart, and The Container Store Group. The Motley Fool owns shares of, Lumber Liquidators, and The Container Store Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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