For companies that carry a huge
load
of debt, there is no room for error. Cash-flow targets need to be
met simply to assure investors that funds will be in place to meet
future
bond
redemptions. If that fails to happen, then look out below...
For mattress maker
Sealy (NYSE:
ZZ
)
, a recently-released
quarterly report
has highlighted that business simply stinks. As short-sellers see
it, the company's debt burden may eventually push this company into
bankruptcy.
Short sellers have been targeting Sealy for nearly a year. And
though they've scored gains already, they're sticking around
because they see even more downside. The number of
shares
held short rose by 300,000 to 13.3 million shares from the end of
December to the middle of January. That's had a crushing effect on
the stock, as you can see from the chart below.
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Chances are short interest -- which currently represents a whopping
45 day's worth of daily trading
volume
-- will rise even higher. That's because Sealy came out with
quarterly results on Jan. 18, a few days after the most recent
short data were released, that were simply lousy.
Fourth-quarter sales fell roughly 10% from a year earlier to $269
million.
It's not that people are buying fewer mattresses. It's just that
they prefer to buy mattresses from Sealy's rivals. For example,
Mattress Firm Holding Corp. (Nasdaq:
MFRM
)
is expected to boost sales 25% this year (to $860 million), while
Tempur Pedic (NYSE:
TPX
)
is expecting sales growth of at least 10% (to $1.8 billion).
Analysts at Hilliard Lyons say Sealy's sales will actually fall
around 3% this year to $1.2 billion.
To preserve cash, Sealy intends to reduce spending on advertising
and marketing. That may not be wise while rivals are spending
heavily to gain consumer attention. And Sealy may not even show
gains from that cutback because the rising price of raw materials
is expected to pressure margins in coming quarters.
Simply put, Sealy can't afford a sales slump. The just-released
fourth-quarter results show what happens when the sales base falls
by 10%.
Gross profit
fell 75% to $24 million.
Operating income
fell by more than 80% to around $4 million. And a year-ago $0.03 a
share
profit
became a $0.14 loss per share this time around. (Analysts had been
expecting a $0.01 a share profit.)
Here's where things get really tough. That $4 million in operating
income wasn't nearly enough to cover the $15 million quarterly cash
interest expense. In effect, Sealy needs to generate at least $60
million a year just to cover its debt interest costs. That seems
quite unlikely based on current run rates.
Even if Sealy somehow managed to hike operating income up to that
level, it still wouldn't be building up any cash reserves to meet
the company's debts that are coming due in a few years. Right now,
Sealy has $108 million in cash and almost $800 million in
long-term debt
.
Reworking the debt
Back in the spring of 2009, Sealy was wise enough to
restructure
its
debt load
. Had it not done so, the company may have already been forced into
bankruptcy by now, as then in-place debt covenants would have been
breached. Instead, Sealy doesn't face any near-term debt
repayments, and instead has until May of 2013 to come up with $100
million. (Another $350 million comes due in May 2016.)
Might Sealy look again to extend its debt to avoid trouble when May
2013 rolls around? Well, the weak recent financial results make it
that much harder. Lenders would want to see much stronger
cash flow
before committing to any fresh debt that replaces the $100 million
loan due next year, so Sealy needs to start showing much better
financial results -- ASAP.
Even if Sealy can line up fresh funding, then the interest rate
would likely be quite high, due to the company's risky financial
profile. Short sellers are betting it won't even get to that point,
and protection from creditors in bankruptcy court is the more
likely outcome.
Risks to Consider:
If the U.S.
economy
grows materially stronger this year, all mattress makers --
including Sealy could see sales come in ahead of current forecasts.
That would likely give Sealy more wiggle room in its discussions to
roll over its debt. Also, heavily-shorted stocks can be subject to
a
short squeeze
, which can quickly push up a stock as an up-tick in shares leads
to a big rally as short sellers seek to cover their positions.
Action to Take -->
Kohlberg Kravis & Roberts (NYSE:
KKR
)
, a private equity group, took Sealy private in 2004, loaded it up
with debt, and then brought it public again in 2006. That proved to
be a bad move, and the massive debt burden is slowly choking this
company. Coming quarterly results are likely to bring the debt
concerns into even sharper focus as cash flow remains sub-par.
Short sellers appear to have a solid case, and you can profit by
also shorting this stock.
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.