Shares of mattress-maker Tempur-Pedic International, Inc. (TPX) fell a whopping 48% Tuesday after the company lowered its guidance for the quarter and the year. This consistent generator of high returns on both equity and capital now trades at a P/E (based on its newly-lowered expectations for the current year) of just 8! Does this represent an opportunity to buy a company with a competitive advantage at a great discount?
Over the last several years, Tempur-Pedic has stolen market share from other mattress manufacturers as demand has shifted from traditional spring-type mattresses to the kind of specialty (e.g. memory foam-type) mattress in which Tempur-Pedic specializes. But the traditional mattress makers (including Simmons, Serta and Sealy) have been hard at work coming out with specialty-mattresses of their own.
This quarter, Tempur-Pedic came out with an early warning that as a result of competition in the specialty mattress segment, its sales will actually fall this quarter year-over year. Supply of specialty mattresses appears to be growing faster than demand, pressuring Tempur-Pedic's volumes and prices.
Tempur-Pedic is able to charge a premium for its product, resulting in historical operating margins in the low 20% range. This year, op margins are now expected to come in at 13-14%, as a result of operating leverage, but there are likely some levers the company can pull going forward to bring costs down. The company is in the middle of building itself a brand new headquarters, requiring abnormally high capex. It has also gone on an employee hiring binge, having increased its workforce by about 20% over the last year, even though revenue is now expected to be flat. Going forward, the company should be able to reduce spending if the promotional environment in specialty mattresses remains.
Even if it is not able to charge as high a premium as it once did due to price competition, Tempur-Pedic will likely still be able to grow and quite profitably at that. The company is still only in 7,900 of the 11,500 furniture and bedding stores in North America, and in just 5,200 out of 8,000 international stores it has targeted.
To maintain its moat, the company pledges to continue to invest in innovating and marketing. It's also worth noting that the mattress industry correlates with the housing industry, and since home sales are depressed, the mattress industry's numbers as a whole should improve over the long term.
Even if the operating environment has changed, which it may not have, Tempur-Pedic is still well-positioned to continue to generate growth with little in the way of investment. At it's current P/E of just 8, Temper-Pedic may turn out to be an excellent long-term investment.