Tempur-Pedic International: Demand Rising Despite Price Hikes

Tempur-Pedic (TPX) makes premium mattresses and pillows made from its proprietary TEMPUR-brand, visco-elastic foam. The company generates sales in more than 70 countries. About a third come from outside the U.S.

TPX’s largest product category is mattresses, which accounted for 70% of sales during the first half of 2007. Price points for queen-size mattresses range from $1,200 for the OriginalBed to $5,800 for the GrandBed. Other models include the SymphonyBed and BellaSonnaBed, which were introduced this year. Models differ on factors such as the number of layers, the density of the material used, and the quality of the covering.

About 13% of first-half 2007 sales came from pillows. This category includes traditional shaped pillows and pillows that are ergonomically contoured for extra support of the head, neck, and shoulders. Remaining sales are from the Other category, which includes mattress foundations, adjustable beds, mattress overlays, cushions, and neck supports designed for travel and the office.

The retail channel, which produced 82% of first half sales, includes furniture stores, sleep shops, specialty gift retailers, and department stores. About 8% of sales were direct to the customer through television, radio, print, and Internet advertising. About 4% of sales came from the healthcare channel, which includes hospitals, nursing homes, physical therapists, sleep clinics, chiropractors, and massage therapists. Remaining sales came from third-party distributors in 60 countries who can access customers not easily reached by TPX’s own distributors.

To capitalize on the growing trend toward specialty sleep products,TPX has expanded and improved its presence in the retail space. Its products are currently sold in approximately 6,350 stores in the U.S. and 4,670 stores abroad. Although this retail expansion has cannibalized sales from the higher margin direct channel, it has also resulted in increased volumes, improved productivity, and a fatter bottom line.

Net sales in Q2 jumped 17.7% year-over-year to $257.6 million. Worldwide retail sales surged 21.7% to $210.9 million. Despite cannibalization, direct sales climbed 3.1% to $21 million. Healthcare sales grew 10.8% to $11.3 million. Third-party sales fell 4.3% to $14.4 million. Depreciation and startup costs associated with a new manufacturing plant in Albuquerque weighed on the gross and operating profit margins, which declined 30 and 17 basis points, respectively, to 48.35% and 21.40%. However, flat interest expenses and a lower effective tax rate helped boost net income by 26.1% to $32.93 million or 39 cents per share.

Investment risks include weaker discretionary spending for premium goods and rising raw material and transportation costs. However, demand for TPX products appears to be inelastic as unit volumes sold continue to rise despite price hikes instituted on several models. Management is planning additional price increases on at least two models. Based on improving expectations, management raised full-year guidance. Second half sales and earnings are now expected to grow 9-13% and 29-33% per share, respectively. Profit margins should improve over the longer term as startup costs subside and production rates improve in the new Albuquerque plant. Management does not anticipate significant increases in capital expenditures in the near future. The stock should receive support from a recently authorized repurchase plan.