The Container Store: Does a “Retail Funk” Justify Selloffs?

Source: Thinkstock

Source: Thinkstock

The Container Store Group Inc. (NYSE:TCS) is a very specialized retailer that caught my attention when I saw it was down over 10 percent in the first hour of trading after reporting its quarterly earnings. This specialty retailer’s stock is down by almost 50 percent since hitting a 52 week high of $47.07. So who is this company? The Container Store is engaged in the retailing of storage and organization products in the United States. It operates in two segments — The Container Store and Elfa.

The company’s retail stores provide various lifestyle products, including bath, box, closets, collections, containers, food storage, gift packaging, hooks, kitchen, office, shelving, storage, trash, and travel, as well as its Elfa products. It operates 66 stores with an average size of approximately 19,000 selling square feet in 24 states and the District of Columbia. The company also offers its products directly to customers through its website and call center. In addition, it designs, manufactures, and sells component-based shelving and drawer systems that are customizable for any area of the home comprising closets, kitchens, offices, and garages, as well as made-to-measure sliding doors to various retailers and distributors in approximately 30 other countries around the world on a wholesale basis.

One good thing for the company is it doesn’t face too much pressure from competition. A few retailers compete with The Container Store, including Walmart (NYSE:WMT) and Bed Bath & Beyond (NASDAQ:BBBY). However, Walmart is of course so much more than a speciality retailer, offering just about everything. However, it does pilfer some business. Bed Bath & Beyond is perhaps a greater threat as it is a bit more specialized and offers many products that do compete with The Container Store. One interesting thing to note is that Bed Bath & Beyond has struggled of late. This was also reflected a bit in The Container Store’s earnings.

The Container Store’s net sales were $173.4 million in the first-quarter, up 8.6 percent as compared to the first-quarter of fiscal 2013. Net sales in The Container Store retail business were $149.7 million, up 8.9 percent as compared to the first-quarter of fiscal 2013. The increase in net sales was driven by new store sales and the extension of its Annual Elfa sale in the fourth-quarter of fiscal 2013, which led to an increase in merchandise delivered to customers during the first-quarter of fiscal 2014 as compared to the first-quarter of fiscal 2013. This more than offset the comparable store sales operating measure decline of 0.8 percent. Elfa third party sales increased 7.0 percent during the first-quarter of fiscal 2014, as compared to the first-quarter of fiscal 2013.

The company’s gross margin was 58.1 percent, a decrease of 30 basis points compared to the first-quarter of fiscal 2013. This decline in gross margin was primarily due to an increase in discounted merchandise delivered to customers in the first-quarter of fiscal 2014 due to the extension of its annual Elfa sale in the fourth-quarter of fiscal 2013. These declines were partially offset by improved margins at Elfa primarily due to improved leverage of fixed costs during the quarter.

Expenses also rose in the quarter. Selling, general, and administrative expenses increased by 9.3 percent to $91.2 million from $83.4 million in the first-quarter of fiscal 2013. Further, these expenses as a percentage of net sales increased 30 basis points primarily due to ongoing costs incurred related to becoming a public company, as well as preparation for future growth and strategic initiatives. Net interest expense decreased to $4.3 million from $5.6 million in the first-quarter of fiscal 2013. What is more, the company’s effective tax rate for the first-quarter of fiscal 2014 was 35.0 percent, which is significantly higher as compared to 29.6 percent in the first-quarter of fiscal 2013. Kip Tindell, Chair and Chief Executive Officer, had extensive comments regarding the quarter that you should be aware of. He stated:

“We thought our sluggish sales were all because of weather and calendar shifts that began last November and continued into the spring, but now we’ve come to realize it’s more than weather and calendar. Consistent with so many of our fellow retailers, we are experiencing a retail funk. Our comparable store sales declined 0.8 percent in the first-quarter. It is important to remember that historically, first-quarter at The Container Store is by far our lowest from both a sales and profitability standpoint. Simply put, it represents less than zero percent of our annual earnings. So were disappointed with the first-quarter, but the first-quarter has very little impact on our full year earnings results.

“We are confident that customer enthusiasm for our brand, and employee morale are at all time highs, yet we continue to experience slight traffic declines in this surprisingly tepid retail environment. While consumers are buying homes and automobiles and even high ticket furniture, most segments of retail are, like us, seeing more challenging sales than we had hoped early in 2014 so were not alone in this. We believe well have a slight improvement in the second- and third-quarters. But we are very much looking forward to the fourth-quarter as we comp against the worst weather we had in our history last year and believe we will see marked improvement in our sales trends. Historically, over 60 percent of our profitability has been derived in the fourth-quarter, so from a profitability perspective fourth-quarter is very important for us.”

That bolded statement is responsible for much of the selloff in the stock. The stock has dropped by over 10 percent since the release. The quarter was weak, although it was a year-over-year improvement. So what do I think should be done? To be honest, the stock has dropped a lot. I would not recommend a sale at these prices. Those who bought in at higher prices should hold the stock and give the company a chance to turn the corner. I actually think that at these severely depressed levels, someone looking to fill a retail niche in their portfolio could go ahead and start a position here and add to it on further declines. I do, however, see the selloff as overdone and think we will soon see a reversion to the $26-$27 levels.

Disclosure: Christopher F. Davis holds no position in The Container Store and has no plans to initiate a position in the next 72 hours. He has a hold rating on the stock and a $27 price target.

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