Mattress and bedding company Tempur Sealy International Inc (NYSE: TPX ) has been on a roller coaster over the past several quarters.
Tempur Sealy stock dropped big in early 2017 after the company announced it was cutting ties with its largest customer, Mattress Firm, after renewed partnership talks turned sour. Mattress Firm accounted for roughly one-fifth of TPX's total sales, so losing Mattress Firm as a customer was a big hit.
But Tempur Sealy stock proceeded to rebound over the next several months. The company rattled off a few strong quarters in a row that illustrated the strength of Tempur Sealy outside of Mattress Firm. Sales excluding Mattress Firm in North America were rising at a fairly consistent 10% rate, and by November 2017 , TPX had regained one-third of lost Mattress Firm sales.
Then, things got worse. The company rattled off a few disappointing quarters in a row. Most recently, sales in North America rose just 4% in the important holiday quarter.
Consequently, Tempur Sealy stock has dropped from $65 to $40 in 2018.
This sell-off seems overdone. TPX has now moved largely past the Mattress Firm headwind, and growth everywhere else is positive. Meanwhile, margins are doing just fine and are back to normal levels.
In other words, everything seems "OK" at Tempur Sealy. But Tempur Sealy stock is at five-year lows.
That makes no sense. Thus, I'm a buyer here and now.
Here's a deeper look:
Tempur Sealy Is Getting Back to Normal
All signs point to the fact that Tempur Sealy is finally moving past the Mattress Firm headwind and returning to normalcy.
Revenue growth excluding Mattress Firm in North America was 4% last quarter. While that is a slowdown from 10% earlier in the year, revenue growth before the whole Mattress Firm fiasco was around 2-3%. Thus, 4% is actually above normal.
For all intents and purposes, then, Tempur Sealy is back on track in terms of revenue growth.
Moreover, margins, which were hit hard in the first few quarters following Mattress Firm's exit, are now back to normal. Not only are they back to where they were before the Mattress Firm exit, but they are actually above those levels.
Last quarter, TPX reported its highest gross margins since acquiring Sealy in 2013.
Broadly speaking, then, revenue growth and margins are actually above their historical levels, once you back out Mattress Firm. With the Mattress Firm headwind now moving into the rear-view mirror, total company revenue growth and margins will start to look better than ever before.
Tempur Sealy Stock Isn't Priced for Normal
Tempur Sealy stock isn't priced for this better-than-normal, or even normal, growth.
Revenue growth has historically run around 2%. Last quarter, without Mattress Firm, it was 4% in North America. Thus, revenue growth over the next several years should be able to run around 2-4%.
Meanwhile, gross margins are now at historic highs. Operating margins are a bit off their highs, due to increased marketing expenses. But that increased marketing spend is largely a result of losing business with Mattress Firm, and once that headwind falls away, so should those expenses. Thus, margins should trend higher over the next several years.
Adjusted operating margins were 11.9% last year and 13.6% the year before. In five years, margins should not only rebound to 13.6%, but also surpass that level, thanks to higher volume selling at higher price points. All in all, operating margins of 15% seems reasonable in five years.
A 3%-revenue growth rate puts revenues in five years at $3.19 billion. A 15% operating margin on those revenues implies operating profits of $479 million. Taking out $100 million for other expenses, 27% for taxes, and dividing by a presumably reduced share count of 50 million, equates to roughly $5.50 in earnings per share in five years.
A market-average 16-times forward multiple on those $5.50 earnings implies a four-year forward price target of over $88. Discounted back by 10% per year, that equates to a present value of over $60.
Bottom Line on Tempur Sealy Stock
The company is doing very well in its post-Mattress Firm days. The stock, however, is not, and that is an opportunity.
Tempur Sealy stock currently trades around $40. I think it's worth $60. That makes me think Tempur Sealy stock is a steal at current levels.
As of this writing, Luke Lango was long TPX.
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