Sleep Number Corp. $SNBR
Sleep on this one first. zzzzzzz.....
When you think of buying a new bed or mattress, is this what pops into your head? Let’s have a look at an interesting public company that is trying to get you to shift away from this cringe-worthy thought.
What do they do?
They sell mattresses and other bedding related items and aim to market their products as superior to the competition using “sleep science”. They operate stores in a direct to consumer business and also have an online presence. They’ve been doing this since 1987 and have been rather successful. According to their own filings, they represent approximately 8% of the market in the US and have admitted that this is a competitive business with generally a commodity like product (not ideal in most cases). They currently operate over 600 stores in North America.
Do they make money?
Yes. Their revenues have steadily increased over the past 10 years and their gross profits and free cash flows have followed suit. There seems like there is no rest for the wicked in this business (aha). Any-who, the business seems like it is more profitable that one would have guessed initially. Despite it being a competitive business, they have sustainably enjoyed a comfortable 55-60% gross margin and have worked successfully to increase the free cash flow margins over the past several years.
They have enjoyed good returns on equity and invested capital over the last decade at around 30-40% for ROE and around 10-20% for ROIC. Certainly not a destroyer of capital over the recent past and given the boring, routine nature of the business, unlikely to drastically change.
Are there reinvestment opportunities?
It seems likely that they will continue to grow their sales through a shift to online or omnibus routes for sales growth. This seems the case for increased margins on the free cash flow side of things as a physical store presence seems less than a requirement than it may have been in the past.
Its not clear what strategy they will undertake going forward in the way of reinvestment opportunities. They have used their cash in the past to routinely repurchase sizable amounts of their shares outstanding and this has helped propel the value of the shares remaining. To put a number on it, they have halved the number of shares in the past 10 years.
Is there a risk of a blow up?
As long as they continue to do what they have been doing, it doesn’t seem likely. From a financial risk perspective, they carry some modest amount of debt and not a lot of cash on hand. This is a concerning sign and would be something to consider before making any investment decision. In order to sleep well at night, I would prefer that businesses carry cash if they are going to carry debt. They have an Altman-Z score of 3.86 which is good (not an immediate bankruptcy risk) and a Beneish-M score of -2.79 which is a good sign that they are not cookin’ the books.
Is management sketchy?
No. They don’t appear on the surface to be doing silly things with shareholder capital and have had a focus on the industry that they are trying to extract value. If they make some crazy future growth through aggressive acquisitions, then watch out.
Does it have a moat?
I would say not really. They have done a reasonably good job at developing and marketing a quality brand in a business that doesn’t naturally lend itself to one. One could argue that scale is their moat in the business but I would caution as there are plenty of retailers with scale that could enter the competition and develop similar branding over a reasonably short amount of time.
Is it cheap?
Not really. Compared to its own history, it is relatively expensive on most metrics (PE, Price-sales, EV/EBIT, yadda yadda yadda). That being said, it is reasonably priced if you are a long term holder and they are able to maintain some growth as well as fend off the competition and maintain these types of margins. Compared to the broader market, it is close to average in terms of numerical valuations.
The issue with the business not being cheap is that this business is well… a little sleepy. One of the big reasons for the share price trajectory over the last decade has been the ability of management to buy back shares at reasonable valuations as well as slowly grow the top and bottom lines. This is the dual engine of growth that was possible over the past decade. Even if the business fundamentals continue (no guarantee that they will be as good), there is no ability to take advantage of the low share prices to buy back stock and if management continues to buy back aggressively at high valuations, this would actually hurt the remaining shareholders going forward.
While the business traditionally has done well in a sleepy industry, the ability to allocate capital towards repurchases is a risk going forward. This could put management into an awkward position and potentially also lure them into making questionable decisions going forward. At lower valuations, this one might be one worth revisiting… if you do plan to include this one in your portfolio, sleep on it first! (couldn’t help myself)
Hit me up on twitter for any feedback or ideas @MoS_Investing
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