Mattress Firm - Another Deal, But Is There Appeal?

Sep. 1.14 | About: Mattress Firm (MFRM)

Summary

Mattress Firm makes another deal, this time acquiring Back to Bed.

The latest deal just adds to anticipated and reported revenue growth as reported by the firm.

Despite the rapid growth and share price momentum, I am cautious amidst a premium valuation, the increase in leverage and integration challenges.

Investors in Mattress Firm (NASDAQ:MFRM) have been pleased with the modest acquisition which the company made at the end of August.

The acquisition of Back to Bed is the latest deal in a string of acquisitions made in recent years, allowing the firm to rapidly grow its operations. Even more growth is anticipated in the coming years. While these deals have fueled profits and the share price, debt has increased substantially as well in the meantime. This makes it difficult to grow the business without diluting the shareholder base or pushing leverage to excessive ratios.

The big momentum in the shares have made the shares rather expensive based on valuation metrics, also given the integration challenges and the leveraged financial position. As such, I will avoid making an investment at current levels, but will add shares to my watchlist in case that a significant sell-off might occur.

Deal Highlights

Mattress Firm announced that it has entered into an agreement to acquire Back to Bed, adding to its presence in the Chicago area as well as certain areas in Florida.

With the deal, Mattress will acquire 135 mattress specialty retail stores in new and existing markets. To acquire the business, the company will spend some $60 million to be financed out of existing cash holdings and the capability of its revolving borrowing terms.

The deal is expected to close in the third quarter of this year.

Implications Of The Deal

CEO Steve Stagner is happy with the deal stressing that it immediately adds to scale in the Chicago as well as Florida market.

The deal is consistent with the company's strategy to gain relative market share in selected markets, thereby creating shareholder value like it has done when making previous deals.

June Investor Presentation

Back in June, Mattress Firm presented itself again to its investors, stressing the opportunities for future growth.

At the end of the first quarter, the company operated some 1,365 stores across the US, thereby serving a target population of 137 million customers. In the very long run, the company anticipates to operate some 3,000 stores which could cover the entire target population in the US.

Yet this is the very long-term prediction with sales in 2018 foreseen just below the $2.5 billion mark, as the company anticipates to have a store base of little over 2,000 stores at that point in time. The general long-term goals by the company are quite aggressive as well. Mattress Firm anticipates to open 8-10% of its store base per annum which should be complemented with 2-5% growth in annual comparable store sales.

These aggressive sales targets are expected to be complemented with operating margins north of 10% of sales. Adjusted earnings per share excluding the impact from potential future deals should result in the targeted 20% earnings per share growth.

Underlying the anticipated growth is the shift from traditional department and general furniture stores towards mattress specialty retailers which are now making up 50% of the entire market. This shift combined with mattress prices increasing has benefited the firm. It must be said that the low demand during the recession has resulted in a higher average age of mattresses, resulting in the potential for pent-up demand in the future as well.

Successful History Of Rapid Expansion

Mattress Firm sold its shares to the general public back in 2011 at a price of $19 per share. Shares have seen their fair share of volatility in the meantime, but they have generally drifted upwards. After shares have tripled ever since, they are currently changing hands around all-time highs of $57 per share.

Between the year ending on January of 2010 and the past year, the company managed to increase sales from $434 million to $1.22 billion. The company posted earnings of $53 million over the past year which compares to a break-even result four years ago.

This growth was driven by deals in particular driven by the 2012 acquisition of Mattress Giant with some 181 stores. The company has made many other deals in the meantime, including the 2014 deal to buy SleepExperts and Mattress King Bedmart, adding some 55 and 75 stores, respectively.

Looking At The Valuation

Earlier in August, Mattress Firm announced the preliminary second-quarter results, posting an impressive 9.7% growth in comparable store sales. The definitive results will be published on September 4.

Total sales growth came in at 35.5%, aided by acquisitions of course, with second-quarter sales totaling $410 million. GAAP earnings are predicted to come in between $0.39 and $0.42 per share, while non-GAAP earnings are seen between $0.58 and $0.61 peer share.

Full-year sales are seen between $1.54 and $1.58 billion, while GAAP earnings are expected to come in between $1.59 and $1.65 per share, with non-GAAP earnings forecasted between $2.03 and $2.13 per share. Based on the current equity valuation at little below $2 billion, equity in the business is valued at around 1.3 times sales, 35 times non-GAAP earnings and 27 times GAAP earnings.

At the end of the first quarter, the firm held $12 million in cash and equivalents, while total debt came in at $300 million. Based on trailing EBITDA of little more than $120 million, the net debt ratio is equivalent to 2.5 times EBITDA which is on the high side.

Final Takeaway

I must admit that I am quite impressed with the comparable store sales growth of nearly 10% at the moment. That being said, I don't fancy paying a 35 times GAAP earnings multiple for the business which relies largely on acquisitions for its growth.

With leverage already being fairly high, the potential for large future deals is limited, as the company most likely still has a lot of integration work ahead. With potential for dealmaking being limited going forward without diluting the shareholder base, I fail to see the risk-reward at current ratios. This is amidst the premium valuation, the increase in leverage and integration challenges.

I remain on the sidelines but do find the company quite interesting. As such, I will add shares to my watchlist for the future.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.