This will be a controversial article with my co-workers, in fact, some of them may get on my case. But that's why I love working for The Motley Fool, my company values differing opinions. And as you'll see, some of us disagree greatly on the merit of The Container Store (NYSE:TCS).
I know a good retailer when I see one, I've worked in and analyzed the space my entire life. So when my colleagues first flagged The Container Store, I was excited. But I've read the reports, I've done the research, and I'm sorry to say, I just don't get it.
There is a natural connection between The Container Store and Whole Foods Market (NASDAQ:WFM). CEO Kip Tindell was a roommate of John Mackey. Both retailers believe in conscious capitalism. Both companies spend lots of time training and developing their people. But in my opinion, The Container Store is not an early stage Whole Foods.
The bear argument
Let's take a step back. The Container Store sells 10,000 organizational products, everything from shelving to food storage. It's been around for more than 35 years, it has grown to more than 60 stores, and it does around $800 million per year in sales. So far, so good.
But there are some red flags that we need to talk about. In retail a key metric is same-store sales. Last quarter, Whole Foods grew its same-store sales 4.5% -- that's healthy, especially for such a large company. Last week, The Container Store reported that its same-store sales declined by 0.8% over the last three months. That's bad news.
Last year, same-store sales for The Container Store grew only 2.9%.Strong concepts report healthy and consistent increases in same-store sales, especially this early in their growth cycles. With these weaker numbers, I think there could be more trouble on the horizon.
Conscious capitalism is the bomb... But...
I'm a fan of conscious capitalism. I believe that happy, engaged employees make for happy, engaged customers. And I'm on board with the CEO and founder Kip Tindell. I think he's an incredible entrepreneur, one who really gets it. Heck, I'd work for him.
But that doesn't mean I'm sold on the business. You see, I look for strong businesses anyone can run. The Container Store has no brand image, it sells storage solutions from some 700 different vendors, and it would be fairly easy to duplicate. You mean to tell me that Home Depot, Lowe's, Target, even Amazon.com won't crack these guys?
So what I'm saying is we're not talking about a Whole Foods type business. Whole Foods has built a brand on the back of a cult-like following. Eventually, that concept branched out, and more jumped on board. But even with its head start, larger and more capitalized players are making it tough for Whole Foods to operate.
And that leads me to my next point. I don't think the economics of The Container Store are that good, especially considering its stock price. It has a gross margin of 58%, which is fine, but its operating margin generally sits around 4%. That's because The Container Store spends so much on its people.
Now business picks up around the holidays, but it's tough to eke out a profit when your company is only generating a 4% operating margin for nine months out of the year. Last quarter, sales growth slowed to 9%, but that was with a 10% increase in store count. Again, this doesn't generally happen with young, strong retail concepts.
|The Container Store||First Quarter 2014||Fourth Quarter 2013||Third Quarter 2013|
|Sales||$173.44 million||$216.82 million||$188.3 million|
|Gross Profit||$100.85 million||$126.21 million||$112.94 million|
|Operating Income||$6.68 million||$30.14 million||$6.81 million|
I'm not a huge valuation guy and I'm not a stick to my model (at all costs) type analyst. I believe in paying a fair price for a good business. But I know an expensive stock when I see it. And that's OK as long as the business is fantastic. Unfortunately, I wouldn't classify The Container Store as a fantastic business.
To get a feel for a company's worth, I like to use Michael Mauboussin's Expectations Investing. With this tool, I'm able to figure out the long-term growth rate necessary to justify today's price. Using a generous and normalized structural free cash flow of $40 million (net income + depreciation-non-growth capex), I think The Container Store needs to grow at a minimum of 15% for the next 10 years for today's price to be about right. With the way things have been going (especially with the mediocre 9% top-line increase last quarter), I find it unlikely that the company will hit that target.
Foolish final words
This was a tough article to write. I wanted to jump on the bandwagon, join my friends, and sing the praises of The Container Store. It's a feel-good company with a great CEO.
But retail is hard. Unless you've lived in it for thirty years, you don't realize how hard it is. Whole Foods has grown into a great business that sells consumable products in a growing market. While I don't mean for this to come across as condescending, frankly, The Container Store sells boxes and shelves.
While a bad CEO won't be able to break a great business, a great CEO won't be able to make an average business great. Kip Tindell is a great CEO and a visionary, but I think he's got his work cut out for him.