August 21, 2018 - 5:48pm EST by
2018 2019
Price: 31.93 EPS 1.83 2.24
Shares Out. (in M): 37 P/E 17.4 14.25
Market Cap (in $M): 1,175 P/FCF 0 0
Net Debt (in $M): 180 EBIT 89 103
TEV ($): 1,355 TEV/EBIT 14.4 12.5

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The P/E multiple fell through the first half of 2018 as the Company reported weaker topline trends leaving a seemingly high bar embedded in 2H estimates.  We could see the multiples move back up as store growth and margin tailwinds help the Company hit 2H numbers and 2019 estimates stabilize/potentially start to move up. 


Sleep Number (formerly Select Comfort) manufactures and sells adjustable beds.  The company sells mainly through its retail footprint of 565  stores which generated 92% of sales in 2017 and through online/phone sales which contributed 7%.  The company had an estimated 7% market share of industry retail revenues in 2016.  The industry is competitive, particularly at the low end with many companies entering with “bed in a box” offerings.  


The company’s stock peaked at approximately $40 earlier this year and has since fallen to just over $30 with the PE multiple falling from over 21x to 17.5x today. The stock followed a similar pattern a few years ago as earnings estimates began falling in late 2015 (after the company botched their ERP roll-out leading to customer cancellations/delays), before finally stabilizing and slowly moving up in 2017 ( the earnings multiple dropped below 16x before recovering back to the mid 20’s, as the stock rose from below $20 to the mid 30’s).  The company recently lowered its sales growth estimate for 2018 to mid-single digits down from mid/high-single digits prior.  In addition, they maintained their EPS guidance for $1.70-$2.00 in EPS despite an $0.08 tax benefit last quarter.  Concern now centers on a high hurdle for the 2H and fears of another guide down, possibly leading to further multiple compression.


I believe we could be in front of another period of stabilizing forward estimates followed by upward revisions that could take the stock back into the 40’s.  First half sales disappointed as revenues fell yoy in Q1 but rebounded in Q2.  If we account for $25MM in sales that slipped from Q2 into Q3 in 2017, overall sales were flat in 1H.  Given that the average store count was up 2.5% yoy, and that the company was in the process of rolling out new products, the flat yoy sales performance was a disappointment.  Q2 sales, however, were up 2% yoy (adjusted for the $25MM sales slip last year). The street currently forecasts $800MM in 2H sales vs. $766MM LY or 4.4% growth, in-line with mgmt. guidance for mid-single digit growth.  If you take out the $25MM in the prior year that slipped from Q2 into Q3 the company needs to hit 8% growth. 


Net new store openings should provide a significant tailwind in hitting street numbers in the 2H.  According to company filings they generated approx. $9MM/quarter during the 1H (about 2-3% benefit to revs) from net new store openings/closings and they expect to accelerate the opening activity in the 2H so that TTM net new stores will approach 30 up from 16 last quarter.  Not sure there is a great way to quantify the potential benefit as I don’t know the contribution of stores they are closing or the sales ramp of new stores.  Very high level, 19 net new stores generated $18MM in net incremental sales in the 1H, and based on last year’s seasonality (adjusting for the $25MM sales shift), I believe you could get close to $1MM in incremental sales/net new store in the 2H (again that could be way off depending on the contribution of the stores being closed and ones being opened but that same metric going back through 2016 yields similar results).  $30MM on last year’s 2H base of $766 would be just under 4% sales growth. 


None of that will matter if sales growth for the remaining store base fall apart.  The company finally finished rolling out their new 360 product over the summer, so a lot of this could be derailed if product issues arise.  Having said that, Q2 trends are encouraging as TTM average sales/store was up 4% yoy and going back three quarters the metric was up 1.4%, 2.4% and 5.4% as the mix shifts to higher price point beds. 


Margins should also improve in the 2H of 2018 and into 2019.  The company got hit in 1H on inflation and mix shift to more sourced product.  In addition, the company called out 70bps (approximately $5MM) of impact from running two product lines, which they expect to wind down by year end with another $2MM expected in the 2H.  That incremental step down represents 40bps of GM improvement vs. 1H (the company guided to 50bps).  In addition, the entire $7MM going away will be a tailwind to 2019 margins (40bps vs. current street sales estimates).  The company has further talked about 100-200bps of margin improvement beyond 2019 but details there are limited (they talked about supply chain efficiency and delivering assembled beds, but I haven’t seen them quantify individual components). 


Street numbers currently forecast 60bps of gross and operating margin improvement in 2019 on six percent sales growth resulting in $2.24 in EPS or 20% growth versus the midpoint of 2018 guidance.  Given that the end of product transition costs can generate a big piece of the gross margin improvement and the company has previouly talked about taking opex down to 55% of sales (closer to 56% in 2017), it seems like there could be upside to operating margins if they can hit those sales numbers. 

Management put out a $2.75 eps target for 2019 back in late 2015.  They still seemed intent on hitting as recently as February of 2018 (they will receive special performance awards if they do).  It seems like a stretch (as according to the proxy it will use a higher tax rate), but it may be one of the reasons they are being so aggressive with share buybacks (risky as they are actually increasing leverage to shrink the share base which was down 12% yoy last quarter).  If the Company can hit numbers in the back half of the year, at $32 the stock would be trading at approximately 14.3x 2019 estimates.  I think the multiple can start moving back up past 20x putting the stock in the low $40’s. 



I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.



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