TCS | Outstanding Quarter…A New Era Begins

HERE'S OUR NOTE FROM THE WEEKEND ON WHY WE LIKE THIS NAME 

TCS | NEW LONG IDEA 

Takeaway: Forgotten retailer, new management, new industry tailwinds, new unit growth and margin opportunity. Solid Quad2 name. 3 year, 3 bagger.

We’re adding The Container Store (TCS) to our Long Bias list while we complete our research on what we think is setting up for a Best Idea Long. TCS is another forgotten public retailer.  There is minimal sell side coverage, just 2 hold ratings and seemingly ignored estimates. It was acquired by Leonard Green in 2007, and came public in late 2013.  The stock was quickly crushed as comps went negative in several quarters in 2014-2016, shares fell over 90% over a 2 year time period.  Quickly the finger was pointed at losing share to Amazon, which is only partially correct, but regardless the name was quickly relegated to the basket of 'small cap dying brick and mortar retail that should never have come public.'  

We think that narrative is likely to start rapidly changing.  If you review the model, the business has been incredibly consistent on a margin level, and comps were positive 3 years running before covid, resembling a much better business than most investors likely think.  There simply hasn’t been much happening, declining store growth, managing costs, LSD comps… a boring story.  Now a new CEO is coming in, Satish Malhotra, former COO and Chief of Retail for Sephora -- he starts his new role tomorrow.  We think there is a new growth opportunity emerging for this company – as evidenced by product tie-ins with Home Edit and Tidying Up – TV shows that have gone viral around home organizing. With accelerated square footage growth comes multiple expansion, as we can count on one hand the number of retailers that are actually accelerating square footage. When we look at margins, the company is currently sitting at 5-6% EBIT margins – something we think will see upside to 8-9% as the category tailwind accelerates, new product categories come to fruition, and management streamlines the organization to operate from a better position of strength.  

The stock also fits the Macro framework and style factors we are looking for in this Quad2 market.  It’s small cap, higher beta, high short interest (at 17.4%), and consumer discretionary. The company reports its fiscal 3Q (Dec end) on Tuesday. For this Q we could see some squirrely guidance around 4Q given that the new CEO will likely want a low bar as he starts his new job and runs with his agenda. We’d be buyers of any weakness as we continue to dive deeper on this name that we think is setting up to be a solid multi-year call.

What is The Container Store?
The Container Store is a retailer of storage and organizational products/solutions. It has a mere 93 stores throughout the US at an average size of 25,000 sqft and average lease duration of 5.5years. It serves an affluent customer. More than half of what it sells is exclusive/owned product lines. The biggest category is custom closets, at 50% of sales, the rest is made up of Storage/Shelving, Kitchen & Trash, Office, Gift/Seasonal, and Bath/Travel/Laundry.  It also owns Elfa, a Swedish subsidiary that designs and manufactures component‑based shelving and drawer systems and made‑to‑measure sliding doors. Elfa is exclusive to The Container Store in the US but sells wholesale to other retailers in 30 countries globally.

Long Term Tail
You may have seen one of the popular organization shows Tidying Up with Marie Kondo or Home Edit.  We think these shows could be kicking off a new long term consumer trend in home organizing.  Both of the shows/personalities have recently launched exclusive lines at The Container Store.  At the same time in 2020 people got an opportunity to become intimately reacquainted with their home. We also have seen continued elevated levels of home turnover, particularly at the high end, as city dwellers moved to the suburbs.  We see the increased home ‘awareness’ and elevated turnover as demand drivers for TCS.  The company needs more stores, it's trying out new concepts, but there is an opportunity to simply add more square footage.  For example there are no TCS stores in the entire state of Connecticut.  Post IPO hiccups likely stalled the growth plans, but with new management coming in and some industry tailwinds forming, it's time to accelerate unit growth.  In addition the company has some investments still to make in ecommerce, it does not have an app for mobile devices. 

Trend
As noted above, the quarter being reported Tuesday could have some hair around guidance. However QTD online interest trends appear to be accelerating, and we are heading into easy compares as we lap store closures around covid.  The Home Edit line launched in September and the company saw an immediate comp and rewards member lift.  With the Marie Kondo line launching in January, we suspect the same to be happening driving high sales momentum into the easing comps.

Upside
We’re still actively researching this name, but as we review the model today we see $0.81 in EPS for 2021, and about $1.90 in TAIL earnings power.  Given the growth we expect, we’d put a 20x PE on 2021 for as stock of about $16.50  or 20% upside to fair value. That's nice, but not what we're playing for.  Over the TAIL, given the accelerated square footage growth we expect to see in the model (one of the few in Retail doing so) we think a mid-twenties multiple on our Tail EPS is reasonable, meaning a stock of $40-$50 over 3 years or a 3-bagger from its current $14. Note that post-IPO, this stock hit $46.61...our upside might seem steep, but trading above $40 is hardly uncharted territory -- especially as the narrative around the name becomes more growthy and profitability/returns break out to the upside.