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Pencils Fund Purchase: Select Comfort
Purchase Price: 21.19
Purchase Date : 10/27/06
Shares Purchased: 8
Commission: 6.95
Business
Select Comfort was founded in 1987 in Minnesota. Select comfort engages in the development, manufacture, and marketing of adjustable-firmness beds primarily in the U.S. and Canada. The Sleep Number bed is something you probably have heard of, or maybe you even own one! Select Comfort also offers bedding product accessories, such as pillows, sheets, comforters, etc. Select Comfort sells its product through its company-operated stores (of which there are more than 400), catalogs, web sites, mass merchants, and discount clubs, just to name a few. For advertising, Select Comfort primarily runs television infomercials and runs ads in newspapers. Select Comfort's mission is to provide America with the highest quality beds to give the highest quality sleep. Several people I know say that the Select Comfort beds are incredibly comfortable and have cured their inability to sleep. Select Comfort has special partnerships with Radisson Hotels and Resorts (this partnership was announced in May 2004) and Winnebago Industries.
Financials
Some quick numbers:
Market Cap 1.14B
Enterprise Value 1.09B
Employees 2,485
Shares Outstanding 53.71M
Float 51.87M
% Held by Insiders 4.25%
% Held by Institutions 111.30%
Qtrly Earnings Growth (yoy) 36.60%
Qtrly Rev Growth (yoy) 22.10%
Revenue (ttm) 765.09M
Gross Margin (ttm) 60.53%
EBITDA (ttm) 98.80M
Profit Margin (ttm) 6.50%
Oper Margins (ttm) 10.15%
Return on Assets (ttm) 22.73%
Return on Equity (ttm) 37.56%
Net Income (ttm) 49.74M
EPS (ttm) 0.879
P/E (ttm) 24.08
P/S (ttm) 1.48
Total Cash (mrq) 38.31M
Total Debt (mrq) 0
As you probably have figured out by now, I love investing in great companies that have been unnecessarily punished by the market. There is no better time to find these types of investments than in earnings season, which is now upon us. Unfortunately for the bargain hunter, this time earnings are being received quite well, and the bargains aren't as plentiful as this summer. But, I believe I've found a good opportunity here with Select Comfort.
Select Comfort recently released its 3Q earnings on October 24. Everything to me looked good: Earnings increased 25% from the 2Q, 39% YOY, margins increased, and the 15 new company stores were experiencing higher-than-management-expected results. But you have to watch out for what those analysts find! Select Comfort reported revenue of $208.3 million, which was under the $211.5 million analysts were expecting. The stock got downgraded yesterday (Wednesday) and the stock fell 17%. The business value rose during the quarter and the market value fell. There is no better combination in the stock market, because it is what creates bargain opportunities.
I love the management team running Select Comfort. Although several of them are quite new to the company, they are extremely focused, honest, and straightforward with fellow shareholders. I listened to a recording of the conference call this morning, and even though their business hit a rough spot (which they believe is largely because of declining home sales and rising mortgage rates, lowering the buyers in the mattress market), they were able to have a successful quarter. But, they were very disappointed with the last 3 weeks of the quarter, and they have made it their mission to get through this rough patch in the short-term and work for the long-term. They are very focused on long-term results, but they understand that the short-term results need to be there to get to the long-term; overall, I really like their management style. Their goal right now is to achieve 20%-25% net income growth and 15%-20% revenue growth.
The feeling I got was that the company-operated stores are going to be a big focus over the next 5-10 years in the way of growth. Right now, management's goal is to get 1000-1500 stores domestically (and probably in Canada as well). It'll be interesting to see how this goes in the future. Considering that they have no debt and a good amount of cash, I'm even more comfortable with this investment, because they have very good financials, are reasonably priced, and run by a terrific management team.
What to Look For
-- Expansion - I doubt we will see Select Comfort expand outside of the U.S. and Canada anytime soon, because there is a tremendous growth opportunity here right now anyway. I personally expect them to stay here for at least the next ten years, but it depends how things go along with the business and mattress market. In any case, it'll be something I watch closely.
-- Management - I love to see a good management team stay with a company. I'm hoping this team stays with Select Comfort for many years to come, because I think they are the right people to help the company grow and expand in a profitable way. They certainly make me comfortable with who's running the company, so hopefully they stay for a good amount of time.
-- The mattress market - This is the obvious one. If people stick with spring mattresses and don't upgrade to this new generation of mattresses, that's the main thing that will destroy Select Comfort. I think we will see Select Comfort do very well, especially considering that the baby-boomers are getting close to retirement (which would probably boost the demand for mattresses -- especially comfortable ones). In any case, this is the most important thing to keep an eye on, because obviously, without a good market, Select Comfort won't survive.
Risks/Competition
I view the primarily risk as competition. The competition, as I see it, is the spring mattresses. Like I mentioned above, it all depends on if people are ready for what really is a new generation of mattresses. Judging by the excellent testimonial for Select Comfort beds, I'd say that people will "accept" them. But I see that as the most important risk and the largest competition.
Another thing I love about Select Comfort's management is the amount of innovation they carry. Obviously, innovation is what created their products, but they are continuing to have ideas and some will be coming out in the next couple years. Select Comfort has the financials, innovation, and management to get the majority of mattress-purchasers to get a Select Comfort product.
Valuation
As I mentioned before, management has made it their goal to achieve 20%-25% EPS growth (I believe this is for the next several years). Analysts are expecting 23% annual growth for the next five years. After researching this business, I think 22% annual growth and a P/E of 20 is a reasonable expectation, and that is my expectation. I think this is a company that can growth at a nice rate for the next ten years, so it is difficult to assess what the next five years will bring. It all depends on how aggressive management gets and if they can keep advertising expenses down while doing so. I'm confident they can. Anyway, my estimate:
.879 * (1.22^5) * 20 = 47.51
My rosy estimate is 27% annual growth and a P/E of 25:
.879 * (1.27^5) * 25 = 72.60
My low, doomsday estimate is 15% annual growth and a P/E of 14:
.879 * (1.15^5) * 14 = 24.75
Conclusion
There's nothing like picking up a great company at a great price. Select Comfort's business is still very much intact, nothing makes me believe a 17% drop in share price was reasonable. With the focused management, good valuation, and an innovative product that is becoming increasingly known, this opportunity is just too good to pass up.
Tags:
business, investment, pencils fund, select comfort, stocks, valuation
Posted at: 11:11 AM | Add Comment
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