- Tempur Sealy has a more diversified business model than Select Comfort and will likely outperform Select Comfort going forward.
- The company is ramping up marketing spending to capture more market share at the expense of Select Comfort.
- Tempur Sealy remains the only mattress company with exposure to international markets.
- Look for margin expansion to return later this year as the company completes the integration of Tempur-Pedic and Sealy.
There's a great deal of debate among investors about which mattress stock should be in one's portfolio. The choice comes down to either Tempur Sealy International (TPX) or Select Comfort Corporation (SCSS). For starters, and what attracts investors, is that everyone needs a mattress. The mattress industry remains a great way to play the housing rebound and economic recovery in North America.
For me, that's where the similarities between Tempur Sealy and Select Comfort end. Select Comfort is entirely reliant on the North American market, and matter of fact, the high-end of the market with its premium mattresses. Tempur Sealy, on the other hand, is now the world's largest bedding provider and sells its mattresses across the globe and at all price points.
Fellow SA Contributor and analyst, Shaun Currie, laid out the pros and cons of investing in Select Comfort in his excellent article. His bullish thesis rests on the drop in Select Comfort's share price over the past several months and that shares of Select Comfort represent a great value in today's market.
Well, I see things differently in that Tempur Sealy is the better buy. On the surface, Select Comfort is the better value based on all the metrics discussed in Shaun Currie's article; however, Select Comfort looks to be a 'value trap' for investors. Tempur Sealy is positioning itself to grow market share at the expense of Select Comfort. The result will be Tempur Sealy will grow its top-line, while Select Comfort will continue to post weak results and lose market share.
As I'll discuss, Select Comfort's strategy this year is to not increase its marketing spending. The company is hoping to basically 'coast' through the year. This will be a costly mistake as Tempur Sealy is going to get aggressive with its marketing spending and look to boost its top-line.
The other reason why I like Tempur Sealy is its exposure in international markets. One can buy a Tempur Sealy mattress in Europe, Asia or Latin America. So while Select Comfort is totally dependent on the recovery in North America, Tempur Sealy's business model has the company hedged with exposure to fast-growing and developing markets.
Tempur Sealy's Q4 results came in better than expectations. The company posted EPS of $0.66, which was $0.03 better than expectations. Revenue of $678.1 million came in $13.63 million higher than analysts expected.
I saw several items in the earnings report, and heard on the earnings call, that I liked. International sales returned to positive growth in Q4 with sales gains seen across Europe, Asia and Latin America. North America sales were down slightly at -1%, but sales of mattresses priced above $2,000 grew for the third consecutive quarter. This hits at the heart of Select Comfort's business with its premium mattresses.
New product innovation can drive sales gains this year
Tempur Sealy was active on the R&D and product innovation side in Q4 and rolled out a record number of new products in January. Among these included the new Tempur-Cloud and Contour launches, which are the largest launches in the company's history. These new products consist of seven new beds with new designs, upgraded comfort, additional cooling features, and removable and washable top covers.
In the high-end part of the market, the company's Stearns & Foster brand introduced a new mattress with special Outlast material and air vents for improved climate performance. This mattress also comes with Intellicoil-encased springs, cashmere covers and hand tufting.
In the $1000 to $2000 price bracket, Tempur Sealy unveiled its new Optimum collection. These are five new beds featuring more Outlast material, more general memory foam from the top to the bottom of the mattress, and taller profiles.
What I like most about these new product introductions is that they are not only resonating with consumers, but more importantly, with retailers. Retailers like the fact that all the lines fit together and that there are logical price points. I think the acceptance by retailers is key because every time I've bought a mattress, there was always a salesperson there to help. By having the support of retailers, the retailers are more likely to push the sales of Tempur Sealy products.
An aggressive marketing push this year
This year the company will increase its marketing budget. The focus is to target consumers and drive retail traffic and demand at the expense of its competitors like Select Comfort. The company plans to advertise on TV year-round and increase its TV spending around major holidays. The company will gain more impressions per dollar following its recently negotiated media buy.
This aggressive push was evident in Q4. The company spent $71.4 million, or 10.5% of sales on advertising. This is 30% higher than Q4 of 2012.
To make retailers' jobs easier, Tempur Sealy has launched new point-of-purchase materials to make its bedding products more appealing. These include new fixtures and signage, new headboards, and new top of bedding merchandise. And they not only make Tempur Sealy's products more attractive, but they increase sale conversion rates.
Integration of international operations presents a tremendous opportunity
Tempur Sealy is still working to integrate its Tempur-Pedic and Sealy international operations. At the company's Investor Day presentation last September, the company said that it anticipates over $300 million in revenue synergies in international markets. The company is aggressively taking steps to realize those savings.
This month, the company regained the distribution rights for Tempur-Pedic in Mexico. They were previously held by a third party distributor. This will allow the company to grow in Mexico where Sealy has a much larger presence than Tempur-Pedic. By now controlling the distribution rights for Tempur-Pedic, the company can boost sales of all products in this fast-growing market.
Last month, the company began integrating Sealy Canada and Tempur Canada. In Canada, Sealy is the market leader. After the integration is complete, the company can now cross-sell all products and capture more market share and extend its strong lead in this important market.
International results are already starting to speak for themselves. In Q4, Tempur International net sales increased 4.7% and direct sales increased 16.3%. What I like most about international is that it has the highest gross margin across the company's divisions at 60.1%.
Margin expansion opportunities
Q4 gross margin came in at 40.2% compared to 50% in the prior year. The reason for this is that Sealy has lower gross margins than Tempur-Pedic. As Tempur International integrates both operations, gross margins will turn higher. Furthermore, the gross margin should start to tick up in the latter part of this year after the company's new product launches have already been rolled out and into the marketplace. The combination of Tempur-Pedic and Sealy allows for cost efficiencies related to sourcing, manufacturing and distribution. Operating margin for this year will likely be between 11.7% and 12%.
Earnings and debt outlook
I see 2014 as a transition year for Tempur Sealy as the company continues to integrate Tempur-Pedic and Sealy. Many of these synergies will bear fruit in 2015, especially as the increased marketing spending allows the company to capture more market share. For this year, I'm in agreement with the consensus and forecast the company to earn $2.76 a share. Next year is when I see earnings kicking into gear and margins improving, resulting in EPS of $3.45 a share. That puts the company trading at only 14.3x next year's earnings, which is the same as Select Comfort's forward P/E of 14.01. Sales will likely come in at $3 billion for 2015. In terms of debt to EBITDA, the ratio will likely come down from 4.4x to 3.8x by the end of this year.
I know there are those that say Select Comfort makes a better mattress and is the best mattress on the market. Well, as someone who has slept on countless mattresses in my travels, to me they're all the same. Once my head hits the pillow, I'm out. That's why Tempur Sealy has the better business model. Most people I know do not over-think the purchase of a mattress. They just need one and make the purchase.
I look for shares to get a boost this year on the back of strength in international sales, particularly in Europe, the return of warmer weather in North America, and the company's new product launches helping to boost sales.
While I agree with Shaun Currie's analysis from a value perspective, Select Comfort cannot compete with Tempur Sealy's business model. Select Comfort's total reliance on the high-end of the market leaves the company exposed to consumers trading down in terms of price points. Furthermore, what hurts Select Comfort is that it's mattresses last and come with a lifetime warranty. This stops consumers from trading up, unless they need a new size. For these reasons, I see Tempur Sealy as winning the mattress war and being the better bet for investors looking to play the mattress space. One major investor that agrees with me and owns Tempur Sealy and not Select Comfort is David Einhorn and his Greenlight Capital with a 1.8 million share position.