1 Big Problem With The Container Store

Shares of The Container Store (NYSE: TCS  ) have plummeted since the company's IPO last November, as optimism over the purveyor of storage and organization products seems to have faded. After reaching a high of around $47 per share earlier this year, the stock has been cut in half, and a disappointing earnings report from the company earlier this month, along with talk of a "retail funk," has added fuel to the fire.   

TCS Chart

TCS data by YCharts

Much has been written about The Container Store; here's a good overview of the company, along with some pros and cons of investing in its stock. The growth story seems to be there, with the company looking to increase its store count by a factor of five over time. It also has a 35-year history that at the very least shows that the concept is sustainable. There's one big problem with the company that I can't get past, though.

Seasonality and costs
In the company's annual report, the following statement appears:

Our storage and organization product offering makes us less susceptible to holiday shopping seasonal patterns than many retailers. In addition, our marketing plan is designed to minimize volatility and seasonal fluctuations of sales across periods.

This sounds like a big positive for the company, as many retailers, especially specialty retailers, see big swings in revenue and profitability throughout the year. The problem is, this statement doesn't tell the whole story. The very next sentence in the annual report is:

Historically, our business has realized a higher portion of net sales, operating income and cash flows from operations in the fourth fiscal quarter, attributable primarily to the impact of Our Annual elfa® Sale, which starts on December 24th and traditionally runs through early February. In fact, in excess of 60% of our adjusted net income was derived in the fiscal fourth quarter in the past three years.

The holiday quarter has higher sales and operating income due to an annual sale. Fine. Backing out the effect of this sale, based on the first statement, sales and profits would presumably not fluctuate much from season to season.

Here is The Container Store's revenue and operating profit broken down by quarter in fiscal 2013:

Quarter

Revenue (Million USD)

Operating Profit (Million USD)

1st quarter

$160

$0

2nd quarter

$184

$11

3rd quarter

$188

($1)

4th quarter

$217

$21

Source: Morningstar

While revenue doesn't fluctuate too much from quarter to quarter, the majority of the company's operating profit comes during the holidays. It's not that the holiday quarter is simply more profitable, it's that the other quarters are largely not profitable at all. In the first quarter and the third quarter, the company essentially broke even before interest and taxes.

On one hand, the products that The Container Store sells aren't really seasonal. On the other hand, the company is largely unable to turn a profit without a holiday sale. This seems to point to The Container Store's prices simply being too high throughout the year. A gross margin of nearly 60% is nice, but if sales volume isn't high enough to turn a meaningful profit while a sale isn't going on then the prices probably need to come down.

Compare this to a specialty retailer like Bed Bath & Beyond (NASDAQ: BBBY  )  :

Quarter

Revenue (Million USD)

Operating Profit (Million USD)

1st quarter

$2,612

$323

2nd quarter

$2,824

$390

3rd quarter

$2,865

$375

4th quarter

$3,203

$527

Source: Morningstar

Bed Bath & Beyond is far larger than The Container Store, but the company manages to turn a significant operating profit during every quarter and its lowest quarterly operating margin is still well in excess of 10%. The gross margin for Bed Bath & Beyond hovers around 40%, around 20 percentage points lower than The Container Store. This leads to the conclusion that The Container Store is sacrificing sales volume in order to maintain its hefty gross margin. With the current level of operating costs there isn't much room to cut prices, so the company would need to cut back on the above-average wages that it pays its employees.

The Container Store is in the position where it can't cut costs without giving up its employee-centric culture, it can't lower prices without cutting costs, and it can't increase sales and turn a sustainable profit without lowering prices. The Container Store is just scraping by at this point, and interest from the $350 million in debt is wiping out most of the company's feeble operating profit. Premium brands are supposed to make premium profits. The Container Store appears to only have half of the equation figured out.

The bottom line
When I look at The Container Store, I see a company that barely sells enough product to keep its head above water. The company spends nearly 55% of its revenue operating its stores, a number that looks outrageous compared to Bed Bath & Beyond (which spends 26% of revenue on operating expenses) and essentially every other retailer out there. Even RadioShackwhich is on the verge of collapse, only spends 46.5% of its revenue operating its failing stores. I just don't see a good reason to invest in The Container Store. Sure, the company can build new stores, but if they have the same economics as the existing ones then it doesn't seem like the investment is worth it.

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Read/Post Comments (5) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 22, 2014, at 5:42 PM, SteveL103 wrote:

    I subscribe to one of Motley's premium products and I believe Dave Gardner recommend TCS in back to back months last year when it was in the 30's. Clearly to have bought in back then was a losing proposition. Since TMF owns shares, wonder if any gurus will weigh in on why we should buy it now?

  • Report this Comment On July 23, 2014, at 9:55 AM, etbob1 wrote:

    Motley Fool bragged about how incredibly great TCS was for a whole year! Now its just a discard to be mocked and ridiculed!

  • Report this Comment On August 01, 2014, at 11:14 AM, alanjanelle wrote:

    i bought it at $38 when Motley Fool promoted this company in December as a must buy... now its a 44% negative value. It makes me feel stupid and i guess thats why the stock market is gambling..

  • Report this Comment On August 20, 2014, at 3:48 PM, MiserblOF wrote:

    I got clobbered on this one too. Still think it's a long term good investment, but might want to wait to see some kind of bottom before adding to my small-and-now-smaller holding.

    I watched facebook after the IPO and was going to buy at 21, but didn't have the cash when it hit. Used loose change to buy a whole 6 (That's six, yes) shares at 19.52. Sure wish it was 600.

  • Report this Comment On August 20, 2014, at 4:10 PM, joryko wrote:

    This demonstrates two things:

    1) Don't immediately buy any IPO. Ever. Even if it is a Foolish recommendation. It is too risky and very rarely pans out. Give yourself time to watch the company report a couple quarters worth of earnings and then decide.

    2) If you're not comfortable buying at an all time high (which TCS was early in its IPO), be ready to spread out your investments in the company over time. No matter how strong the company, if you invest at an all time high, and only there, right before the market drops you are susceptible to a major drop. Simple dollar-cost averaging.

    Also, the stock market IS very similar to gambling. Except the odds are stacked in your favor over time.

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