Shares of Tempur-Pedic (TPX) are trading with losses up to 20% in after hours trading on Tuesday. The manufacturer of premium mattresses and pillows reported a surprise loss for its third quarter, after the market close.
Third Quarter Results
Tempur-Pedic reported third quarter revenues of $347.9 million, down 9% on the year. A strong dollar had a negative impact on sales, and on a constant currency basis sales were still down some 7%. Analysts expected the company to report revenues of $364 million.
The disappointing revenues are attributable to weak performance in North America, where sales fell by 14%. International sales increased 3%, and were up 11% on a constant currency basis.
Gross margins fell 320 basis points to 49.2% as a result of a changing product mix and increased promotions. Operating income fell 34% to $63.4 million. Operating margins fell seven percent points to 18.2%. Operating income includes a $3.6 million charge related to transaction costs from the acquisition of Sealy, and a positive $8 million re-evaluation of incentive stock based compensation.
The company reported a GAAP net loss of $2.0 million, or $0.03 per share. The company was forced to report a net loss as a result of acquisition costs of Sealy and tax costs related to the repatriation of foreign cash balances.
Adjusted net income came in at $42.3 million, or $0.70 per share. On average, analysts expected Tempur-Pedic to report adjusted earnings of $0.69 per share.
CEO Mark Sarvary commented, "Changes in the competitive environment that we experienced during the second quarter in North America continued to have an adverse impact on our third quarter performance. We recently launched a broad series of new initiatives in response to the new competitive landscape in North America, and while it remains early, we are seeing some stabilization as a result. The initiatives are more expensive than we initially estimated, however we are committed to returning to growth."
Outlook
On the back of the disappointing developments, Tempur-Pedic is lowering its full year outlook. Full year revenues are expected to come in around $1.40 billion. The company is also lowering its full year adjusted earnings guidance, to an estimated $2.55 per share. Earlier, the company guided for annual earnings of $2.80 per share.
Tempur-Pedic expects to take further charges related to repatriation of foreign earnings, and transaction costs related to Sealy, in the fourth quarter of the year.
Valuation
Tempur-Pedic ended its third quarter with $151.7 million in cash and equivalents. The company operates with $649.5 million in long term debt, excluding the deal with Sealy, for a net debt position of $500 million.
For the first nine months of 2012, Tempur-Pedic generated revenues of $1.06 billion. The company reported a net income of $83.3 million, or $1.31 per diluted share.
Factoring in a 20% decline in after-hours trading, the market values Tempur-Pedic at $1.55 billion. This values the firm at 1.1 times annual revenues and roughly 10 times adjusted annual earnings.
Currently, Tempur-Pedic does not pay a dividend.
Investment Thesis
Year to date, shares of Tempur-Pedic have lost some 50%. Shares rose from the low fifties in January to highs of $87 in April. Two profit warnings further, shares hit lows of $21 in the summer. Shares recovered to $35 in recent weeks and are currently exchanging hands at $26 per share.
Over the past five years, shares trade with modest losses. Shares traded as low as $5 in the beginning of 2009 and rallied to $87 earlier this year. Between 2008 and 2012, Tempur-Pedic increased annual revenues from $928 million to an expected $1.4 billion in 2012. Net earnings rose from $59 million in 2008 to an expected $155 million in 2012. Note that the earnings estimate for 2012 is adjusted for one-time items.
It came as a big surprise when Tempur-Pedic announced the acquisition of Sealy in September. The timing of the acquisition was quite surprising given the operational and competitive pressures which the company is facing. The acquisition of Sealy will increase the net debt position of Tempur to an expected $1.7 billion. The addition will almost double annual revenues from $1.4 billion to $2.7 billion. Sealy is hardly profitable, yet annual cost synergies are expected to reach $40 million per annum in three years time. Based on a modest recovery in 2013 and initial cost synergies, pro forma earnings could reach $200 million in 2013 - at least $3 per share.
I think the market is slightly overreacting in Tuesday's trading session. While slower growth in the mattress market is more prolonged than previously anticipated, and competition is more severe, the company does offer long term prospects. A successful integration and signs of a recovery could send shares back to levels over $35 per share.
I might initiate a long position in the coming days.
