The Container Store's (NYSE:TCS) 10-month run as a public company was recently described as "intense," "stressful," and "a little bit illogical." And that was coming from the company's CEO, Kip Tindell. I'm sure investors have some choice words of their own after watching this stock crater 53% year to date.
Thus far, it has undoubtedly been a painful ride for shareholders (myself included). But as long-term Foolish investors, let's not get bogged down in the short-term hiccups and ignore the underlying business. The Container Store's self-proclaimed "funk" could subside by the end of winter, and it's good to see a management team stay the course in a desperate retail environment.
With time, this funk will fade
For any retail business, "same store sales" is a critical metric that gauges both demand for its products and the effectiveness of its pricing strategy. Early on, healthy retailers tend to excel in this category.
From their perspective, a single quarter blip could be an accident, but two is a sign that something is seriously wrong. Morgan Stanley analyst Simeon Gutman remarked, "For an immature chain with a long growth runway, persistent soft traffic is a clear disappointment."
Here's a look at how soft traffic turned a positive same store sales trend to a negative in the last two quarters.
Investors would like to see the opposite trajectory, of course, but this could be a matter of unfortunate timing rather than permanently disappearing customers.
The Container Store seems to be uniquely suffering from a lingering "funk" that was brought about by the nasty winter weather earlier this year. It was, as Tindell put it, "[T]he worst weather we've ever seen in our 35-year history, which affected nearly all of our stores throughout the country."
While most retailers suffered from the fierce winter storms, the blow was particularly brutal for The Container Store. So much of its annual results depend on holiday and post-holiday season shopping, including 60%-70% of earnings. On the conference call, Tindell elaborated on the situation:
We're the only retailer I know that gears up for its two peak seasons simultaneously. We have to gear up for the holiday season and the elfa sale in the fourth quarter. That's why last year's weather had more of an impact on The Container Store than it does most people because, let's face it, January and February are the two worst months of most retailers' business, and January and February are even bigger for us than December.
The worst part is that the company's lackluster annual Elfa® storage sale has thrown a wet blanket on the overall business so far in fiscal year 2015. This is because Elfa products are like "potato chips," according to Tindell: Customers don't buy just one, they tend to come back for more.
And even though Tindell extended the Elfa® sale this spring, the winter's damage was done. A crucial lever could no longer be pulled, and the weather-driven traffic lull seems to have sealed The Container Store's same store sales fate for at least a few quarters.
Now, I'm not one to give retailers a pass when they blame the weather, but there's little evidence that something else is awry. Average ticket amounts are inching upward to roughly $60 a pop. According to management, new stores are opening to higher demand than ever before. And pricing remains firm, which helped lead to an increase in adjusted net income of 38.7% year over year.
According to most media outlets and analysts, The Container Store appears to be facing an existential crisis. I would characterize their current problem as a temporary but potentially reversible traffic trend. The third quarter will probably not offer much relief, but there's reason to believe that things will return to normal if the fourth quarter witnesses a calmer winter than the last.
Pricing power will prevail
Another reason I'm less concerned about The Container Store's short-term slump is that management's holding firm on pricing to preserve margins. In a highly promotional environment, this will lead to sluggish traffic (as witnessed) but will ensure branding and pricing integrity over the long haul.
In the latest quarter, gross margins (sales less cost of goods sold) actually increased from 58.4% to 58.8% year over year. This figures towers over retailers like Target or Bed Bath & Beyond, which generate 30% and 40% gross margins, respectively. These lucrative margins, in fact, are one of the key reasons I looked into purchasing the stock. As Warren Buffett has pointed out, healthy margins stem from pricing power, which is what really matters in the long run.
Now, The Container Store's management team could have easily looked at ongoing trends and resorted to "blowout" sales to get customers in the door. In the short term, that might have worked out well for same store sales, but discounting can become an all-too-slippery slope.
Just consider the situation that the notorious discounter JCPenney found itself in a couple years back. In 2012, an article in the Harvard Business Review noted that JCPenney's brand became so synonymous with "sales" that it offered 590 sales events in a single year during 2011. That's 1.6 events per day!
JCPenney had completely lost its identity. It found itself in a jumbled bargain bin that was impossible to climb out of. In one decade, JCPenney customers went from demanding a 38% discount to get them to pull out their wallet to requiring a 60% off sale to even bat an eye. Like I said, promotions can lead down an incredibly slippery slope.
As a long-term Foolish investor, I'd rather The Container Store didn't venture down that path. It's one thing to pick yourself up and dust off a few lackluster quarters. It's an entirely different undertaking -- as JCPenney has found -- to convince price-obsessed customers that you're a brand worth paying for.
The takeaway for investors
Right now, the spotlight is shining bright on The Container Store. It's a newly minted IPO stock that attracted hype -- and high expectations -- from the market and the media. Its CEO also happens to be on a well-publicized tour right now for his leadership-focused book, Uncontainable. In light of all the hoopla surrounding the company, is it disconcerting to see shares tumble more than 60% from their all-time high? Of course it is.
However, investors need to separate the noise from the long-term sustainability of The Container Store's business. A combination of inflated expectations, ill-conceived sales guidance from management, and a lingering weather-related slump has caused the stock to take a nosedive. But The Container Store seems poised to get back on track, and I expect this growth story will continue in the years to come.
Isaac Pino, CPA owns shares of The Container Store Group. The Motley Fool recommends The Container Store Group. The Motley Fool owns shares of 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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