Description

We are continuing to dumpster dive in the wasteland of high ticket consumer discretionary businesses that have seen their boom cycles turn into deep cyclical downturns and find ourselves buying another name we were short in 2020/2021.  One of the sectors that has experienced the most pain from a unit perspective relative to recent history is mattresses.  If you looked at the Tempur Sealy chart, which is almost out to new all time highs, you wouldn’t get the sense that unit volumes of 24m in 2023 are as low as they’ve been since 2014.  However, if you pulled up the Sleep Number chart which is down 92% from it’s COVID peak and 75% from it’s pre-COVID trading range you would probably get the sense that we’ve had a cyclical hiccup. Now seems like a decent moment to buy SNBR for the cyclical ride higher. 

SNBR has been written up three times on VIC but here is a bare bones overview:

• They sell high end mattresses, think $5k on average

• Their customers skew older, 45-65 yrs old, $100k+ in avg income

• Unlike the rest of the industry they are fully vertically integrated and sell DTC and through 675 physical stores 

• Their market share has remained constant for the past decade or so, 1.2-1.5% of industry units and 6-7% of industry $ (this figure gets skewed b/c that is wholesale $, retail their share is closer to 8-9%)

We think the normalized earnings power for SNBR is about $3.65 and see upside of over 450% to our $55 target over the next few years, our thesis is based on:

1. The cycle

   • 2023 units will end at ~24m, which is down 27% from the 2020 peak, but this is way more than an unwind of the pull forward, units have not been this low since 2014, and in fact were at these levels in the year 2000 (there are about 130m households in the US in 2023 vs 105m in 2000….)

   • This chart does a nice job of visualizing it

• Why has it been so bad?

  • Every player in the industry will tell you when asked that Consumer Confidence is the #1 driver of their business…this is completely untrue…..existing home sales are the #1 driver (think about moving into a new home and having to buy 2-3 units vs randomly replacing aging existing units, it’s a very low urgency purchase outside of moving)

    • Existing home sales of ~3.8m in 2023 have not been this bad since the GFC and the foreclosure overhang years of 2009-2011

  • We think the bottom has been put in here and the 100bps of yield back up in the 30yr treasury puts 2024 on track for marginal growth

2. There are a few SNBR specific reasons why the stock has been so terrible that we think are either in the rearview mirror or are close to being resolved

   • Semis

     • The product SNBR sells is high end and does rely on an electronic infrastructure to operate, during the earlier parts of COVID they could not source the required chips to ship their higher ASP units

       • It cost them 5 qtrs of demand, pretty material

       • Their competitors were shipping to demand and taking share for about a year

   • Terrible capital allocation

     • They went nuts on buybacks and as a result now have $460m of net debt on a $215m market cap, this is more than entirely explained by their buybacks almost doubling FCF since 2018 (but it also highlights how much FCF the business is capable of creating….)

                                                  2018      2019     2020      2021      2022      Cumulative

                       FCF ($m)              $86       $130      $240      $233      $(33)        $656 

                       Buybacks ($m)      $272     $165      $235      $382      $64           $1,118 

                       FCF/share             $3.74    $5.65     $10.43    $10.13   $(1.43)    $28.52 

• How will this be resolved?

  •            For starters, they clearly don’t have the balance sheet flexibility to even think about buying any stock back 

  •            But more importantly Stadium is involved as an activist and just got two board members appointed as of November

  • Steve MacAdam bought 50k shares in the open market shortly thereafter

• The stock would rip if Shelly was fired 

• They fumbled their advertising message in Q3 leading to a huge SSS miss causing the stock to leg down ~40%

  • SSS were (14%) vs expectations for (MSD%)

  • They claim they were reaching too high in terms of bed + box combos, creating an aspirational avg ticket that was just too high

  • Once reversed,  SSS improved to the (MSD%) into October

3. The numbers and valuation

   • SNBR currently trades at 5.5x our 2024 EBITDA vs TPX at 12x, for sure there are differences in end market exposure and the MFRM acquisition is creating an idiosyncratic situation for TPX but ironically it brings it closer to SNBR’s business model now that they will be in the retail business as well

   • We have added 2019 for reference and our model below makes the following assumptions:

     • They achieve their $50m in cost outs in 2024, speaking w/IR it sounds like they are locked in

     • Incremental EBIT margins are 30% from here, historically 25-35% has been the reality, opex is typically 25% variable on a 60% gross margin 

     • No debt paydown or buybacks

     • We do add back $20m of stk comp to get NI as close as possible to FCF

     • All years, including 2019, are based on 23m s/o

• Once the market believes the bottom in is in terms of units we think the stock will re-rate sharply higher, 15x the 2026 # a year from now does not strike us as crazy

Conclusion

• The Q3 marketing mishap put the finishing touches on a brutal cyclical unwind that was magnified by poor capital management, that’s why the opportunity exists here

• SNBR has been a steady eddy high end producer that has reinvested in R&D (to the tune of $50-60m/year) to maintain their market share, there is no real “problem” with the company’s positioning outside of the cycle

• To us, the risk reward is skewed significantly to the upside, our $3.65 mid-cycle estimate still has EBIT margins well below normalized levels….an activist and two new board members should ensure the right moves are made on the cost side until the cycle officially turns

Catalyst

• Q4 results
• Evidence of mgmt getting the message on cost structure
• 30yr bonds remaining stable/lower