The Container Store Group Inc. Just Fell 25%, and It's Still Overvalued

By Markets Fool.com

Lately, it seems like the only thingThe Container Store Group Inchas been able to contain is profitable growth. The retail stock was one of the more sought-after IPOs when it debuted in late 2013. From an initial price of $18, shares doubled on its first trading day, and peaked above $45 shortly after.

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However, it was a short-lived honeymoon between the organization-minded retailer and investors. The stock tumbled, and is now trading below its IPO price after a 25% drop on a stinker of an earnings report earlier this week.

Source: Container Store website.

During the key holiday quarter, the company saw comparable sales fall 0.8%, capping a 1.4% decline for the full fiscal year. Profits improved modestly as its operating margin expanded, with the company reporting an adjusted earnings per share of $0.24 against $0.22 in the quarter a year earlier. Overall sales increased just 3.4% in the quarter.

CEO Kip Tindell conceded that the quarter was subpar, saying it did not "conclude according to early in-the-quarter trends." Like many retailers, Tindell cited challenging weather, adding, "Weather was a contributing factor, as we experienced winter storms in February during the vitally important last four days of our 50-day Annual elfaSale and during the last week of our 19-day Sale's extension."

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Still, for a national chain to blame four days of weather for impacting an entire quarter's performance seems like a feeble excuse. Tindell admitted that the poor performance went beyond weather, saying,"Our sales performance fell short of our expectations in fourth quarter and in fiscal 2014. We can and will do better."

Despite The Container Store's plans to turn things around by adding new stores and introducing a new line of closets and other proprietary organizational systems, there are still a number of challenges facing the company that investors should be aware of.

Valuation
For a company with almost no growth, the stock is awfully pricey. Based on the last 12 months, The Container Store has a P/E of 50, a valuation normally reserved for fast-growing momentum stocks. The market seems to have priced in the growth that the company is supposed to have instead of adjusting to the realities it's facing.

For the current year, both management and analysts are expecting earnings to be flat, so the stock is unlikely to move higher anytime soon. Negative comparable sales are also a warning sign for a company hoping to add new stores because it means it's already losing the customers that it has.

Finally, the poor results may be understandable if this was a young company that had just finished a rapid wave of expansion -- but that's not the case here. The retailer is nearly 40 years old, and brought in just $11 million in profit last year with 70 stores. The concept isn't new; only the IPO is.

Competition
A look at the list of competitors fighting for the consumer's organizational dollar reads like a who's who list of retail giants. In its attempts to more than quadruple its store count, The Container Store is facing off directly with IKEA,Amazon.com,Target, andBed, Bath & Beyond.

The first two have made low prices a staple of their business models, adding another problem for The Container Store, which pays its employees well, and therefore charges higher prices. IKEA, meanwhile, whose stores can range up to 600,000 square feet, can skew an entire home-furnishings market by opening just one of them. The average IKEA outlet brings in about $100 million in revenue. For comparison, last year the entire Container Store chain made just $781 million in sales.

The biggest problem for The Container Store may be the company's lack of any sustainable competitive advantage. The company likes to pride itself on being a top-ranked employer, and claims to offer better service than its competitors due to the intensive training program it puts its staff through.

However, when it comes to selling durable goods like organizational systems, service may be less important than price, as this is not the type of business generating high-frequency visits the way a drugstore or coffee chain might. Unlike IKEA, which is vertically integrated, The Container Store offers mostly non-exclusive branded items, meaning many of its wares can be found cheaper elsewhere.

Like most businesses, the chain has a core group of customers for whom better service is worth the extra money; but based on negative comparable sales, that does not seem to be enough to drive the store's growth. Without positive organic sales or significant profits, it's hard to justify store expansion.

If the market accepted the reality of single-digit earnings growth, the stock would be trading in the single digits. A couple more earnings reports like this one, and the market may realize the hard truth.

The article The Container Store Group Inc. Just Fell 25%, and It's Still Overvalued originally appeared on Fool.com.

Jeremy Bowman owns shares of Apple. The Motley Fool recommends Amazon.com, Apple, Bed Bath & Beyond, and The Container Store Group. The Motley Fool owns shares of Amazon.com, Apple, 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.