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Pencils Fund Purchase: Select Comfort
Purchase Price: 18.10
Date Purchased: 12/5/06
Shares Purchased: 9
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 financials:
Market Cap 948.62M
Enterprise Value 905.03M
Employees 2,685
Shares Outstanding 52.67M
Float 50.87M
% Held by Insiders 11.26%
% Held by Institutions 111.50%
Qtrly Rev Growth (yoy) 18.50%
Revenue (ttm) 797.57M
Return on Assets (ttm) 24.30%
Return on Equity (ttm) 44.47%
Profit Margin (ttm) 6.55%
Operating Margin (ttm) 10.41%
Gross Margin (ttm) 61.19%
EBITDA (ttm) 107.05M
Net Income (ttm) 52.23M
EPS (ttm) 0.932
P/E (ttm) 19.32
P/S (ttm) 1.21
Total Cash (mrq) 62.02M
Total Debt (mrq) 0
Select Comfort has become even more out of favor with the market after lowering full year earnings guidance to 80-87 cents EPS. Management blames lowered guidance on a weak housing market and increased correlation with housing trends. I think this is a reasonable "excuse," because consumers buy furniture when they buy a house, so there'll most likely be less furniture purchased if less houses are sold. Select Comfort relies on the consumer attitude and market, and there will be rough spots.
From the 2Q to the 3Q, Select Comfort's cash position increased 63% to $62 million while debt is still at 0. The balance sheet is at its strongest right now, so the company can handle a short-term slow-down in earnings. The business also produced $50.73 million in cash flow, by far the strongest cash flow producing quarter they've had. The company is very strong right now, and although the coming 4Q probably will bring a slow-down with financials, I think this price drop has been overdone. This is simply because the long-term prospects of the business are still intact, the company has some new products coming onto the market over the next couple years, and they've got a superb balance sheet right now.
Some have questioned management's honesty. I haven't questioned them at all, because the company bought back $25.07 million worth of stock in the 3Q (and that's also while rising the cash position 63%), by far the largest value of shares they've purchased over the past year. If they didn't believe in the business, they wouldn't be buying back lots of shares.
The market has been acting as though the coming quarter will be disastrous. Sure, it probably won't be great, but the company isn't falling apart. I don't expect the housing market to improve right away, but I believe that we have seen the bottom or are close to the bottom. The coming year might be slow for Select Comfort, and we may be presented with more opportunities, which I'll certainly take advantage of if they come along. But with the strong balance sheet and strong cash flow producing business, we know they aren't going anywhere real soon. Baby boomers are getting older and will probably want comfortable beds, and Select Comfort will definitely do well if this trend does come into play, as most expect, and most likely will come into action over the next five years or so. The bottom line is that the business is very strong, and companies will hit rough spots every now and then. One poor quarter isn't going to scare me away from a company with great resources and a strong business. My long-term view hasn't changed a bit, I still have great confidence in management, and I think Select Comfort will be able to grab a larger market share percentage of the mattress market over the long-term.
Risks-- Housing market stays down longer than expected - I don't expect housing to stay down or slow for more than 18 months, but you never know what could happen. The housing market is a risk that I see mainly in the short-term, but Select Comfort's balance sheet is strong enough to the point that I think management will be able to use it in a smart way and strengthen their presence in the mattress market.
-- Competition - There are many different types of mattresses on the market, and Select Comfort bed's may not be what people want. I think Select Comfort bed's will be the main "new wave" beds, and management has the resources to strengthen the brand name and their position against competitors. They have the balance sheet to compete, and I believe this management team will know how to execute properly and convince consumers to buy a Select Comfort bed.
ValuationMy estimates remain the same from my previous purchase: From an EPS of .879, 22% annual earnings growth for the next five years and a P/E of 20. Today's EPS is .93, but since the 4Q will probably see a decrease in earnings, it'd obviously be lower. But again, I believe the company's long-term position is still very strong, and I believe they'll be able to grow earnings at 22% annually for the next five years.
879 * (1.22^5) * 20 = 47.51
Rosy estimate; 27% annual earnings growth, P/E of 25:
.879 * (1.27^5) * 25 = 72.60
Doomsday estimate; 15% annual earnings growth; P/E of 14:
.879 * (1.15^5) * 14 = 24.75
ConclusionI think this coming 4Q will be a good lesson to management. Hopefully they'll cease to provide such short-term guidance or any guidance at all, but I think management will now know and understand much more the affects of different industry conditions on the mattress market. Overall, nothing has changed in my view, and their long-term potential is still there. With the balance sheet strengthening and the business producing more than it ever has, I believe management will be able to take full advantage of that potential.
Tags:
investing, pencils fund, select comfort, stocks, valuation
Posted at: 01:41 PM | Add Comment
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