Is The Container Store Paying It's Employees Too Much?

By Markets Fool.com

The past year has been a rough one for The Container Store , a small specialty retailer that became a public company in late 2013. The stock is down about 50%, comparable-store sales have been contracting, and profitability has been erratic from quarter to quarter. I wrote about some of the company's problems back in July, and the stock has continued to slide since then. Let's explore what's holding back the company's growth.

Continue Reading Below

TCS Chart

TCS data by YCharts.

Do better wages generate higher revenue?
The Container Store is known for paying its employees extremely high wages, with the average worker earning nearly $50,000 annually. The idea behind these above-average wages is that increased worker productivity will more than make up for the extra cost. This has certainly worked for Costco, which pays its employees an average of $20 per hour while realizing about three times the revenue per employee compared to Wal-Mart.

The problem with The Container Store's high wage strategy, though, is that it simply doesn't work. The company's employee productivity, as measured by revenue per employee, is no better than its peers, and its cost structure is out of control as a result.

Continue Reading Below

Source: Revenue and employee data from YCharts.

In fiscal 2013, The Container Store had sales of $749 million and 5,300 employees, leading to revenue per employee of about $141,000. This is similar to other specialty retailers, like Williams-Sonama, and significantly lower than the much larger Bed Bath & Beyond .

The Container Store pays its employees more than twice the national average of about $24,000 per year for retail sales workers, and while the company claims that these high wages increase productivity, it's clear from the chart above that that's simply not the case. The average hourly wage of a Bed Bath & Beyond sales associate is just about $10 per hour, or around $21,000 per year for a full-time position, according to Glassdoor, but its employees earn significantly more revenue compared to employees of The Container Store.

The company's earnings coupled with extremely high wages has led to The Container Store's operating expenses to be far higher as a percentage of revenue compared to any of its peers.

Source: Data from YCharts.

The Container Store does partially make up for this with higher prices. Its gross margin is just shy of 60%, far higher than Bed Bath & Beyond's 40% gross margin. This allows the company to still turn a profit, albeit with fairly low operating margins. For comparison, The Container Store's operating margin in 2013 was just 4.1%, well below the 14% margin posted by Bed Bath & Beyond.

Looking beyond revenue per employee
As a concept, The Container Store certainly isn't a failure, but I have serious doubts about the growth potential of the company. With wages as high as they are, The Container Store can't compete on price without killing its profitability. With such high prices and stores like Wal-Mart and Target selling similar, lower-cost items, the potential customer base for The Container Store is severely limited. Any new markets the company enters needs to both be large and have enough high-wealth customers to justify the growth.

Also dragging down the company's profitability is its debt load, which totaled $364 million at the end of the most recent quarter. The Container Store paid $17 million of interest on this debt during the past 12 months, eating up more than a third of its operating profit. The company has been spending every dollar of cash flow building new stores, and with very little cash on hand, an unexpected downturn in its business could be disastrous.

Even after the massive decline in the stock price over the past year, the stock still trades at more than 40 times the company's guidance for 2014 EPS, adjusted for one-time items. With plans to increase the total square footage by about 12% per year, it's difficult to see any scenario where a P/E ratio of 40 makes sense. Profitability would need to dramatically improve, and I just don't see that happening while wages remain are so high.

Light at the end of the tunnel?
The Container Store's high wages certainly come with some benefits, including an employee turnover rate in the single digits. But at the same time, the purported productivity gains simply don't exist, and this had led to high costs, which limit the company's ability to compete. This puts a pretty hard limit on the growth potential of The Container Store.

While Costco has managed to turn high wages into high productivity, The Container Store has only figured out the first part of that equation. As it stands, the company's cost structure is out of control, and its debt load is eating away a big portion of its profits. Its prices are high, and it can't lower them without either cutting wages or destroying its profitability. I don't see much of a growth story here, and the stock seems outrageously expensive.

The article Is The Container Store Paying It's Employees Too Much? originally appeared on Fool.com.

Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Bed Bath & Beyond, Costco Wholesale, PetSmart, The Container Store Group, and Williams-Sonoma. The Motley Fool owns shares of Barnes & Noble, Costco Wholesale, and 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.