The Container Stores Bad Days
Board: Value Hounds
The Container Store is much like many other retailers – it makes most of its cash over the period that includes Christmas. Kip Tindell the CEO says it usually averages around 60% of adjusted profits. Adjusted profits are non-GAAP earnings that attempt to put TCS’s net income on a cash basis. Normally I object to this treatment of mutant marriage of cash flow/profit & loss, but in the case of TCS it’s the only way to know how much the percentage of profit is in the fourth quarter.
TCS accounting is a nightmare tangle of charges for impairments, restructuring, IPO related costs and it’s nearly impossible to normalize earnings for several years worth of quarters since the company has only filed two 10Qs and one 10K. Adjusted net is a reasonable way to figure what percentage Q4 contributes to profits.
Counting on one great quarter to make the year is SOP for much of retail and TCS seems to run the same way but is more dependent on outperformance in Q4 than for just 60% of earnings. In 2012 is was 74% or nearly ¾ of the year’s profit and in 2013 it was 65%. This may be the way the company tracks progress but cash flow is a better indicator of how precarious the TCS position might be going into the Christmas quarter than net income.
In 2012 84% of cash flow was made in Q4 and in 2013 it was 80%. TCS started 2014 in a cash flow hole of $7.8 million, spent $13 million on stores and is free cash flow negative to the tune of $21 million.
Cash flow is critically important since Kip intends to increase the pace of growth of stores and square feet in 2014. The plan is to open/move/remodel eight stores. At last year’s cost per store the cost would be $41 million and maintenance capex will run around $27 million –CFFO needs to be at least $68 million to cover it. In 2013 CFFO was $51 million and they spent nearly every bit of it on capex with a scant $3 million left over. That means TCS is going to have to recover the lost CFFO of $7 million and accrue nearly $70 million in CFFO for the year to cover their plans. That’s a lot of cash flow from a company whose best year ever was $51 million.
The relentless need for growth
As a newly traded public company, TCS is forced to play the growth game. They have to open stores and expand territory all the while accelerating earnings and comps to keep the market interested in buying shares. Unfortunately, TCS is going through a prolonged downturn in same store sales and lower revenue growth in spite of steady building of new units. It’s not a new retail funk but a persistent problem.
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There will be trouble growing revenue through opening stores in 2014 if it’s a replay of 2013. Revenue growth has not kept pace with store openings + comps indicating underperformance in stores not in the comp base. Same store sales are so anemic, they can’t make up for the rest of the fleet of TCS units and bring revenue growth in line. Comps are only positive through price increases doing little to offset declining traffic. If TCS doesn’t turn the trend by Q4 with traffic and more substantial revenue growth and net earnings, cash flow is not going to cover the capex needs. The market demands growth and if TCS keeps failing to meet expectations, share price won’t see much love and appreciation.
By becoming public, Kip made a pact with a devil he doesn’t seem to understand. TCS may be a retailer better left out of the light of public scrutiny. Why did they do an IPO? They raised very little cash for expansion—most went to pay preferred dividends and a term loan. The Tindells made $53 million and maybe that was reason enough. It obviously wasn’t intended to raise cash for expansion—there was none left. It’s a mystery. Maybe they needed to get Leonard Green paid.
Now they are stuck in the growth circle of hell with nothing but cash flow to pay for it and most of that won’t be known or realized until the fourth quarter. It’s a tenuous position. Issuing more debt is an unlikely source of cash for growth for them. Debt to capital is at 67% and much of it is floating LIBOR +3.25% -- an onerous interest rate doomed to go up. Interest consumed 71% of operating income in 2013 and they can’t afford more if they need more cash to fund growth. TCS is in a bind and the fourth quarter is under a lot of pressure to perform.
When TCS reported earnings for the first quarter in 2014 (April, May, June) the market took it down fast by 11% to $24 well off the post-IPO euphoric $47. All through the call, Kip was reminding analysts that 60% of profits would come in Q4 and there was nothing to worry about. In spite of the reassurance, they may have been pondering TCS’s capital structure and need for growth and the uncertainty of a great in Q4 in light of Q1 negative comps and increasing losses in transactions/traffic.
Operating loss was higher year-over-year through increased SG&A, but net income was slightly less negative due to lower interest rates from refinancing. Bother operating and net were negative and there were no outsized one-time charges dragging them down.
While we don’t have the Q1 2013 comps, we can see that Q4 2013 and Q1 2014 are going from unimpressive low single digits into negative territory. A 4.2% increase in price was offset by nearly 3% drop in transactions/traffic. By Q1, price increases weren’t able to offset traffic declines enough to keep comps in the black. This isn’t a recent trend. Same store sales reached a high of 8% in 2011 and have been on a downhill run ever since. In 2012 and 2013 in spite of increasing prices aggressively, TCS traffic offset gains and lowered same store sales.
For some reason Kip doesn’t see this as a problem. Almost anyone who follows retail would think otherwise.Kip TindellComp store sales have only two components, is traffic and average ticket. And so what we trying to outline for everybody is -- here’s what we doing about traffic and we really believe the POP! will move the needle on traffic, but what we really think we can do something about is this average ticket thing and we’re really excited about it.
So, for us its easier to raise average ticket than it is to raise traffic and I think that’s probably -- because we have these well paid, well trained sales people and then we have the average tenure in our buyers is like 17 or 18 years, so we’re bringing* in higher end product that the customers been asking for. Gosh, the average first-year employee at The Container Store gets trained, how many hours Melissa? (280)Philosophical difference of opinion short aside
There is far too much investment in employee training for selling shower caddies, hampers, canisters, drawer organizers etc. SG&A is a big expense and until revenue growth can leverage all the high-priced help, TCS’s bottom line is going to hurt. You can do anything you want as a private company, but on Wall Street there is a ruthless efficiency dictating what a company has to do to make earnings. Overpaying and overtraining staff is a luxury (unless you are an investment bank). Back to it
The POP! is simply a customer loyalty program rolled out one year ago in 15% of the stores -- traffic keeps dropping. It’s intended to take care of the traffic woes but so far hasn’t had much of an impact. The nation-wide rollout is this year. Something to watch.
ATHOME custom high-end products is the other initiative to raise comps. Average ticket will be $2000 if TCS can sell them and it’s intended to raise average ticket pricing. It seems unlikely. There is big competition in the space with more stores:http://www.californiaclosets.com/locations
Their own line Elfa is falling short of moving pricing up at just a $600 an average ticket and 33% of sales. Tindell admits it has no appeal as the closet solution in master suites and is relegated to kid’s rooms, laundry rooms and the guest bedroom. While sales are adequate, they are low margin and cost intensive. Closet solutions is an area where over-trained sales people may actually be needed.
There is a ceiling on price increases for utilitarian fungible household products and by looking for luxury sales, Tindell may be realizing the end is near for relying on price to drive comps. In 2013 sales per SF were only $138 and the average ticket just $60. Under the gun and Q4 is coming
The Container Store was probably best left as a privately held company run for the benefit of the owners, preferred investors and employees. Growth in that setting is inconsequential and profits are nice but if everyone gets paid and management makes a good living with little left over it’s nobody else’s business at the end of the day. Now it’s everybody’s business that buys shares and the game has changed. By Q4 TCS better have the $68 million they need for 8 new stores and ATHOME and POP! need to be pushing comps back to high single-digits. If TCS falls short again and trends don’t reverse, the market won’t be kind. That’s short term thinking measured in quarters but that’s life for a public company. There will have to be major shifts in philosophy and strategy to win shareholder love over the long term.