Is It Time to Give Up on The Container Store?

Shares of The Container Store (TCS -0.46%) plunged more than 40% on Oct. 31 after the retailer's fiscal second quarter numbers missed analyst expectations. The company's revenue rose 3% year over year to $224.5 million, falling short of estimates by $0.6 million.

The Container Store's adjusted net income fell 15% to $4.7 million, or $0.10 per share, failing expectations by four cents, while its adjusted EBITDA dropped 8% to $24.3 million. Those numbers were weak, but was the stock's massive decline justified?

A businessman stands beside a wall painted as a stock chart and watches a stock plunge into the abyss.

Image source: Getty Images.

What went wrong at The Container Store

The Container Store is struggling to stay relevant against bigger rivals like Amazon, Walmart, Home Depot, and IKEA, which all carry similar products alongside a wider assortment of goods.

It's basically stuck in the same trap as Bed Bath & Beyond (BBBY): Its products aren't fancy enough to attract high-end shoppers, while lower-end shoppers are flocking to its more diversified rivals. Third-party sales at Elfa, the company's Swedish subsidiary, have also been throttled by tough currency headwinds.

Yet The Container Store's stock rallied sharply earlier this year, surging from about $5 in January to $12 in August on signs that its new sales optimization and revitalization strategies were boosting its comparable store sales. That brief growth spurt seemingly ended in the second quarter with just 1.3% comps growth:

Period	Q3 2017	Q4 2017	Q1 2018	Q2 2018
Comps growth	(0.2%)	2.7%	4.7%	1.3%

Source: The Container Store.

As in previous quarters, the company attributed its comps growth to strong sales of custom closets, which generated 2.3% comps growth. However, that expansion offset by a 1% comps dip in its other products.

But were the results that bad?

Despite its comps slowdown, the company reiterated its full-year outlook for 1.5%-2.5% comps growth, 3%-4% sales growth, and a 46%-82% jump in its adjusted earnings. Those figures all matched analyst expectations. Analysts expect The Container Store's revenue and earnings to rise 2% and 16%, respectively, next year.

Second-quarter consolidated gross margin expanded 30 basis points versus the prior year to 58.2%, with a margin expansion at its namesake brand slightly offset by a decline at Elfa. The organization also expects to open four new stores, including two relocations, during the fiscal year.

Image source: Getty Images.

This all indicates that The Container Store is in much better shape than Bed Bath & Beyond, which expects to post flat comps growth and a double-digit earnings drop this year.

However, a few main problems sunk the stock this quarter. During the company's earnings conference call, CEO Melissa Reiff admitted that "elements of our merchandise campaign test and learn efforts, mostly around our other product categories, did not resonate with customers as well as we expected," and that the failure hurt the company's comps and earnings growth. Second, following the report, JPMorgan analysts downgraded the stock from Underweight to Neutral, with a price target of $6.

The retailer also remains highly vulnerable to rising tariffs, since 37% of its products came from China last year. Management estimates that 12% of its total purchases would have been impacted by the current tariffs. The company plans to mitigate that threat by shifting its sourcing and attempting to convince suppliers to partly absorb the higher costs.

Lastly, The Container Store's stock had perhaps become overvalued after its massive rally earlier this year. Investors should remember that the stock rallied about 40% after its first quarter report in August, and that it was trading at nearly 30 times this year's earnings at its peak. At $6, the "TCS" symbol trades at a more reasonable 14 times current-year earnings.