Tempur Sealy Q3: Outperforming Rivals, But Is 18% Spike Justified?

| About: Tempur Sealy (TPX)

Tempur Sealy International (NYSE:TPX) posted better than expected top and bottom line numbers on Wednesday after market close, driven by significant improvement in Tempur's North America revenues on successful marketing campaigns, strong growth in Sealy's Canadian business. Operational improvements aided as well, with third quarter gross margin coming in at 40.6% - up 200bps from 38.6% in Q2 on "lack of inventory revaluation charge ... and lower new product launch costs". Still, margins have fallen significantly from the 49.2% last year due to lower-margins incurred within Sealy's segment. Lastly, bedding volumes have been down throughout, with unit decline of 4% in North America and 7% Internationally.

The company affirmed its guidance for the fiscal year, calling for revenues "towards the upper end" and adj-EBITDA and adj-EPS "closer to midpoint", sighting "unfavorable mix" as the reason for divergence.

Following the report and the conference call shares spiked more than 18% intraday on Thursday, topping out at $47.37 per share and closing at $44.96 - from $40.11 close prior to the release. Although the report has been quite decent in itself, I think the big question in everyone's mind is whether we have witnessed an over-reaction or if this is in fact a turning point in Tempur Sealy's bearish outlook sentiment.

The Reaction:

First and foremost - there are obviously technical and industry-related drivers for the major gap-up. Part of it - the exceptionally high amount of shorted shares - 22% of float, resolving into a short ratio (or days to cover) of roughly 7.2. The second part - the earlier fallout in Select Comfort Coproration's (SCSS) results, which missed expectations by a large percentage and lowered guidance for the rest of the year.

It is no surprise the highly negative sentiment surrounding Tempur Sealy and large skew towards bearish positions. As a result - the quarterly expectations beat paired with a slight boost to the topline guidance sent shares flying the next day on more than 5x 3-month average volume.


The upside is certainly justified, but was the report worth an extra 20% to the company's market cap? While the report does hold a number of positive developments, the company is clearly not out of the woods just yet.

Tempur North America (TPNA):

The key driver to the better results in the quarter is the 0.6% sales growth, compared to guided midpoint expectation of a 7.5% decline. This 8.1% divergence translates into roughly $19.5 million in sales - accounting for vast majority of the $25 million in topline outperformance.

Management pondered the success of revitalized marketing campaign and its positive impact on adoption amongst retailers and consumers alike. Company plans to invest even more dollars into R&D and marketing going forth to expand on these early success steps.

Tempur International:

Came in weaker on continued European slump, which has been at least partially offset by emerging markets which reported strong growth and product reception. From the outlook perspective, management is highly optimistic on international opportunities, all in light of Tempur-Sealy being "the only provider with global scale".


Management elaborated on "strong demand in Canada" but beyond that - not much comparison could be gathered, as pre-acquisition third quarter 2012 Sealy's numbers "are not ours".


Consolidating the above and focusing on the quarter alone, it is certain there is a change for the better in the TPNA segment. The drivers are none the less uncertain. It could be that the marketing campaign has been all that successful, or the really homerun-hit with the new product introduction, or potential market share gains from Select Comfort's issues... or it could be simply a single quarter event in a fairly volatile industry, unsustainable going forth in the long-term.

While management reiterated its guidance for the 2013, it is important to note the TPNA reversal into Q4 from earlier "decline 5% to 10% in the second half" to the now "0 to low single digits growth". In other words basically taking the third quarter performance and extrapolating it to the fourth quarter. Somewhat opportunistic if you ask me...

It is also worth to note that the third quarter ended right ahead of the 2013 Government Shutdown which lasted for a few weeks, and as talk on the street here around the capital - resulted in a number of contractor layoffs. On the call, management affirmed the "weaker trends in the latter part of September". And although it is November now - no even partial hint at performance in October has been given...

Investment Thesis:

In summary, the industry remains highly volatile and to me, the 18% reaction to results is certainly unjustified. At least just yet given the single quarter results. In the long-term, I think the business now has a good opportunity to run. International expansion is certainly achievable and European slumber is also bound to end at some point. TPNA also seems to show signs of a turn around, although the global reported sales decline, industry competitiveness and issues that some rivals face slightly challenge that thesis. Further yet, company has still much to garner from the synergy perspective on Sealy acquisition integration.

In the near-term however, I think there is much uncertainty yet still. The company balance sheet is still loaded with debt and aggressive guidance for R&D and advertising spend certainly require strong revenue support. And with the still flaky macro picture, burdened by likely Government Shutdown Part 2 in early 2014 and potential Tapering activities from the Fed, I think Tempur Sealy will still have at least a few challenges down the road.

Like many I have been coming in short into the quarter, being a Tempur bear for quite a few quarters and expecting results in sympathy to those of Select Comfort (NASDAQ:SCSS). At this point though, I'm about to throw in the towel and wait for a bit more certainty. Trading on the results, I've been able to improve my break-even to around $43.5-44 per share and optimistically hopeful for a pullback below that to exit the stake. Further yet, should the shares decline into the $40s, I may actually explore a low risk upside scenario through long ITM call options or short ITM put engagements...

And for now, I'll just patiently sit waiting for the short covering rally to end. Adios.

Disclosure: I am short TPX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Home Furnishings & Fixtures, Earnings
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