Things looked a bit disorganized when The Container Store (NYSE:TCS) reported financial results for the first quarter of 2014. The specialty retailer's revenue increased 8.6% year over year, but comparable store sales fell 0.8% due to what CEO Kip Tindell described as a categorywide "retail funk."
As we approach The Container Store's second-quarter announcement, investors are hoping that "funk" didn't carry over into the summer months. Ahead of an earnings announcement on Monday, here are three things investors should focus on to see if The Container Store's finding its groove.
1. We (don't) want the funk!
Let's start, first and foremost, with the funk. When we previously evaluated The Container Store's results, it was too early to tell whether this retailer's woes would be borne out by the rest of the sector. But now we have some perspective.
As it turns out, the funk was less pervasive around the industry than one might have thought. According to a retail industry report by the consulting firm AlixPartners, the "home furnishings" category as a group posted decent comps from March to June. Not including The Container Store, this category's same store sales increased 3.1% through the first quarter and 5% thus far through the second quarter.
Of course, this isn't an apples-to-apples comparison, but these fruits aren't too dissimilar either: Included in the category are high-end retailers like Williams-Sonoma, Kirkland's, Bed Bath & Beyond, Pier 1 Imports, Select Comforts, and Haverty Furniture Companies. Also, the separate home improvement category showed increasing same store sales of 4.5% through July. High-end home shoppers appear to be out and about, but The Container Store has struggled (thus far) to lure them in.
We'll find out whether this was a temporary traffic lull when the company reports on Oct. 6.
2. The brand preservation vs. pricing dilemma
One of the reasons for the variance between The Container Store's traffic and its competitors could be due to promotions. The Container Store stood firm against heavy discounting, while many of its peers did not. As Tindell stated in the conference call, retail in general is in "the most promotional environment I've ever seen in my career."
Thus far, Tindell has shown little interest in heading down that promotion-laden path. This tactic prevents erosion of the brand and preserves The Container Store's enviable gross margins. But he admitted that he and his team are not "foolishly proud," and they are willing to work closely with vendors in case some margin needs to be passed on to entice customers into the door.
Looking ahead, this will be a key metric -- and balancing act -- to watch. In the first quarter, consolidated gross margin dipped only slightly -- down 30 basis points to 58.1%.
As much as investors would like to see the "funk" abate, it would be less satisfying if it came at the expense of, say, a percentage point of gross margin. After all, pricing power is oh-so-critical over the long run, as the legendary investor Warren Buffett attests.
3. What's around the corner?
As Tindell wrapped up the latest earnings call, he was optimistic about a rebound, but still a bit "cautious" and contained. From management's guidance, investors can expect "flat to slightly positive" store comps and a (small) quarterly profit in the second quarter.
Further, it looks like the company might lean more heavily on the fourth quarter this year than they have historically: Management expects 70% of profitability in this period versus a typical level of 60%.
Regarding new products and operations, everything seems to be in the right place. An upscale custom closet offering is taking root in the Dallas-Fort Worth area stores, which could produce an average ticket price greater than the current high-end ATHOME solutions that fetch roughly $2,000 a pop.
Meanwhile, the store expansion effort is humming along: Five of the eight new 2014 stores should be open and operating as The Container Store heads toward square footage growth of 12% by the end of the year. With only 66 stores today, there's plenty of room for another Container Store or two, and management sees the potential for 300 nationwide.
The takeaway for investors
It's true that The Container Store has experienced some growing pains in its first year as a public company, but all of its key differentiators seem to be intact: high-quality products, superior service, and a loyal customer base. If management continues to focus on improving in these areas, the financial results should follow suit.