Why TCS Stock Looks Really Compelling on This Dip

In early February, shares of The Container Store (NYSE:TCS) fell off a cliff after the specialty retailer reported holiday quarter numbers that came up short of expectations on both the revenue and profit lines. Also, management cut its full-year 2018 revenue and profit guides. The double whammy of bad holiday numbers and a weak guide spooked investors, and TCS stock dropped more than 30% over the subsequent several trading days.

But, TCS has shown signs of life recently, rallying more than 15% over the past several days. And with good reason. Down at $5 and change, TCS was way undervalued. Now, the stock is up above $6. It’s still undervalued.

That means this rally in TCS stock has legs.

In the big picture, The Container Store is a stable steady revenue grower with a big enough moat and good enough long term growth prospects to warrant a normal valuation on the stock.

As such, you want to buy TCS when it’s on sale (below normal valuation), and sell it when it’s not on sale (above normal valuation).

Right now, The Container Store stock is still on sale. That means it’s not too late to buy the dip. Upside back to prices above $7 looks doable within the next few months.

Holiday Numbers Weren’t Good

In early February, investors were shaken by bad holiday numbers from TCS. They had every right to be. Heading into that report, TCS stock was trading at a relatively premium valuation, so the numbers needed to be good to justify the valuation.

They weren’t. Instead, comparable and net sales growth went negative. Gross margin expansion moderated towards the flat-line. The adjusted opex rate rose by more than expected. Adjusted operating margins dropped. Profits dropped, too. To make matters worse, the full-year revenue and profit guides were cut.

In other words, TCS had a really bad holiday quarter, and that bad quarter underscored a turn for the worst in the TCS narrative. In early fiscal 2018, TCS was a mid single digit and up revenue grower with mid single digit comps and rapidly expanding margins. Now, TCS is set to close fiscal 2018 with muted sales growth, muted comps, and muted margin expansion.

That’s a bad transition. Thus, it should be no surprise that TCS dropped from $10 and up prices a few months ago, to prices below $7 today.

Long Term Growth Is Stable

Although the underlying growth and margin trends are unfavorable right now, investors shouldn’t throw in the towel on TCS.

Zooming out and looking at the big picture, it’s easy to see that The Container Store is supported by stable albeit relatively muted growth prospects. In the big picture, The Container Store has crafted a niche for itself in a specialty segment of the broad retail category.

Yes, bigger and broader competitors like Amazon (NASDAQ:AMZN) and Walmart (NYSE:WMT) can encroach on The Container Store’s territory. But, they will never do so at a granular enough level to make The Container Store irrelevant or obsolete.

As such, due to its specialty focus in a stable growth category, The Container Store has guaranteed itself stable and healthy long term growth prospects over the next few years. To be sure, growth won’t be big. Revenues will maybe grow by 1-2% per year. Margins will move slightly higher. But, that’s enough growth to warrant further upside in TCS.

Long term, I think 1-2% revenue growth plus slight margin expansion will drive EPS to $0.80 by fiscal 2025. Based on a market average 16 forward multiple, that equates to a fiscal 2024 price target for TCS stock of nearly $13. Discounted back by 10% per year, that equates to a fiscal 2018 price target of over $7.

Thus, fundamentals imply that TCS has upside to over $7 within the next few months.

Bottom Line on TCS Stock

Investors overreacted to bad holiday numbers, and sent TCS stock well into undervalued territory. Now, the stock is gradually climbing out of undervalued territory. It will continue to do so until the fundamentals are maxed out. That won’t be until prices above $7.

As of this writing, Luke Lango was long AMZN. 

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