Is Tempur-Sealy a growth trap? (Part 1 of 2)

Value Investing Case Study 13-1: I first covered Tempur-Sealy in my Seeking Alpha article “Tempur-Sealy: Time To Exit” in Feb 2021. The fundamental analysis then was based on the annual financials from 2010 till 2019. The company has since released its 2020 results which have been incorporated in this article.

 

Tempur-Sealy International Inc (TPX or the Group) is an NYSE-listed global bedding company.  It is currently trading at USD 38.14 (as of 30 April 2021) equivalent to a Price to Book ratio of 25.2. According to Damodaran (Jan 2021 dataset), the average Price to Book multiple for the US Furniture/Furnishing sector was 2.7.

A high Price to Book is usually associated with a growth stock. 

In the case of TPX, looking at book multiples is not the appropriate way to value the Group.  This is because its shareholders’ funds have been reduced by large share buybacks. Any book multiple would be “abnormal”.

But TPX had some exceptional growth. From 2019 to 2020, TPX revenue grew by 10.1 %. Then in the first quarter of 2021, TXP revenue grew by 27 % in comparison with the same period last year while the net income was 190% higher.

Is TPX a growth stock or a growth trap?

A growth trap is a stock that appears to be cheap relative to its growth prospects. But, in reality, the growth is not sustainable so that there is no margin of safety. 

Join me in this 2-part series as I argue why TPX is not a buying opportunity.  The market has overpriced TPX.  Part 1 is presented here while Part 2 was published on 23 May 2021.

Should you go and short? Well, read my Disclaimer.

Contents

• What is so unique about Tempur-Sealy?

• Has it used its Funds in the Best Way?

• Can you describe the Current Performance as Outstanding?

• Is there a Rich and Unique History?

• Is there a Great Future?

• Pulling it all together

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What is so unique about Tempur-Sealy?

In 2012/13, Tempur-Pedeic International acquired Sealy Corporation (Sealy), its biggest competitor.

• Tempur-Pedic International considers itself a vertically integrated manufacturer.  It produces its proprietary TEMPUR material used in the mattress.  TEMPUR is a patented high-density temperature-sensitive material originally developed by NASA.  This viscoelastic pressure-relieving material is commonly referred to as memory foam. 

• Sealy owns some of the most recognized bedding brands in the world. Its strength and expertise lie in innerspring and hybrid innerspring mattress technologies.

After the acquisition, the Group became known as Tempur-Sealy International Inc. The Group went from being a memory foam mattress manufacture to one with comprehensive bedding products. The acquisition gave TPX new product technology and distribution reach. 

The Group today develops, manufactures, and markets bedding products under a number of products and retail brands.

• It has product brands serving all price points eg Tempur, Sealy, and Sterns & Foster.

• It has a number of retail brands eg Tempur-Pedic retail stores and Sleep Outfitters.

TPX distributed its products worldwide through an omnichannel strategy.  This strategy cuts across both wholesale and direct. 

It has 2 business segments - North America and International. 

• North America accounted for the majority of the Group revenue. In turn, the US accounted for the majority of the North American revenue. Note that in 2020, the Mexican operation was reclassified from International to North America.

• International revenue comes from the manufacturing and distribution subsidiaries and joint ventures. These are located in Europe, Asia-Pacific, and Latin America.  

TPX also derived income from royalties by licensing Sealy brands, technology, and trademarks. In 2020, these generated about USD 21.9 million royalties for the Group.

Case Notes TPX had a very different capital structure compared to all the other case studies I had covered. Its shareholders’ funds have reduced over the past 11 years due to the large share buyback programme. From 2010 to 2020, the Group spent USD 1.74 billion in share buybacks compared to the USD 1.72 billion of net income generated during the same period. The number of outstanding shares was reduced from 281 million (adjusted for share splits) in 2010 to 210 million in 2020. The shareholders’ funds even became negative in 2016 but have increased since then due to the retained profits.  One implication of this is that debt is a much bigger part of the total capital employed. Given this scenario, it makes more sense to derive the value to shareholders by first valuing the firm. The equity value is then obtained by deducting the value of debt. Secondly, return should be seen from a total capital basis (EBIT/Total capital) rather than from an equity basis (ROE). Finally, because Sealy has a much lower gross profit margin, I have looked at performance post-Sealy ie from 2014 to 2020. It would appear that assessing a stock is not so straightforward after all. If you are new to fundamental analysis, all this may prove very challenging.   One way to overcome this is to complement your analysis with those of other experienced advisers. Those who do this well include people like Seeking Alpha.* Click the link for some free stock advice. If you subscribe to their services, you can tap into their business analysis and valuation.

Case Notes

TPX had a very different capital structure compared to all the other case studies I had covered. Its shareholders’ funds have reduced over the past 11 years due to the large share buyback programme.

From 2010 to 2020, the Group spent USD 1.74 billion in share buybacks compared to the USD 1.72 billion of net income generated during the same period. The number of outstanding shares was reduced from 281 million (adjusted for share splits) in 2010 to 210 million in 2020.

The shareholders’ funds even became negative in 2016 but have increased since then due to the retained profits. 

One implication of this is that debt is a much bigger part of the total capital employed.

Given this scenario, it makes more sense to derive the value to shareholders by first valuing the firm. The equity value is then obtained by deducting the value of debt.

Secondly, return should be seen from a total capital basis (EBIT/Total capital) rather than from an equity basis (ROE).

Finally, because Sealy has a much lower gross profit margin, I have looked at performance post-Sealy ie from 2014 to 2020.

It would appear that assessing a stock is not so straightforward after all. If you are new to fundamental analysis, all this may prove very challenging.  

One way to overcome this is to complement your analysis with those of other experienced advisers. Those who do this well include people like Seeking Alpha.* Click the link for some free stock advice. If you subscribe to their services, you can tap into their business analysis and valuation.

Has it used its Funds in the Best Way?

As of the end of Mac 2021, TPX had a Total Capital Employed (TCE) of USD 2.45 billion. 

Shareholder’s fund accounted for 13 % of the TCE with almost all the balance from debt. Note that in this context, debt included both operating and finance lease liabilities.

This is equivalent to a book debt to TCE ratio of 87 % compared to the US Furniture/Home Furnishing sector average of 47 % (Source: Damodaran Jan 2021).  

If you translate this into the book Debt to Equity ratio, TPX would have a Debt to Equity of 6.7 compared to the industry average of 0.9. TPX is higher geared.

Items	Ref	USD million
Shareholders’ Equity	SHF	318
Minority Interests	MI	0
Total Debt and Lease	Debt	2,127
TCE		2,445

Items	Ref	USD million
Net Operating Assets	Net OA	2,154
Net Financial Assets	Net FA	291
Non-Operating Assets	Non-OA	0
Total		2,445
Table 1: Sources and Uses of Funds - 1Q 31 Mac 2021

About 88 % of the TCE has been deployed for the operations with the balance tied up in cash. The Group’s cash to the firm value of 3 % is very low compared to the US Furniture/Furnishing sector average of 9 % (Source: Damodaran Jan 2021). But I suspect this is because the value of the firm based on the current market price is relatively high.

Chart 1: Sources and Uses of Funds

The Group did not provide any breakdown of how its funds have been deployed by segments.  However, based on the total assets, the bulk has been deployed to North America of which the majority is in the USA.

Chart 2: Total Assets deployed

Can you describe the Current Performance as Outstanding?

For the 3 months ended Mc 2021, the Group achieved USD 1.0 billion of revenue with USD 131 million net income.

In comparison with the same period last year, the current period revenue is 27 % higher while the net income is 119 % higher.

The increase in YTD sales was driven by “…strength across all its brands, channels, geographies despite a constrained supply chain and pandemic-lockdowns in key European markets.” The higher sales then translated into the higher net income. 

The YTD revenue growth is in line with the long-term improvement in revenue as can be seen from the Performance Index chart below. 

• The jump in revenue in 2013 is due to the acquisition of Sealy.

• There was a dip in revenue in 2017 when TPX lost its largest customer.

• But if you look at the revenue growth post-Sealy ie from 2014 to 2020, it was only a CAGR of 2.3 %.

While there was some revenue growth, gross profitability has declined since 2010.

• Note that the 2010 gross profitability was based only on Tempur-Pedic International gross margins.

• The Group’s margins declined in 2012/13 following the acquisition of Sealy given the lower gross margins.  Since then, there have been some slight improvements in gross profitability.

Net income reduced significantly immediately following the acquisition.  This was due to the large increase in interest expenses for the debt taken to fund the Sealy acquisition. But as can be seen, there is progress beyond the 2010 level since then.

Chart 3: Performance Index

TPX operates in 2 segments - North America and International.  An analysis of the performance of the 2 segments showed:

• The PBT contribution by the North America segment was doubled that of the International segment.

• The International segment performed better on Return on Assets. 

Table 2: Segment Performance

Notes

a) Ave revenue and PBT based on 2014 to 2020 ie post-Sealy

b) The corporate expenses were reported only for 2019 and 2020. Thus, in prior years North America and International segments PBT included the corporate expenses

c) North America and International segments’ assets included investments in subsidiaries. These were eliminated on consolidation. The remaining inter-segment eliminations comprised intercompany accounts receivables and payables. 

d) Return on Assets = Ave PBT / Total Assets

e) In 2020, Mexico was reclassified as part of the North America segment. Unfortunately, except for 2019, TPX did not provide historical info for other years. The segment results are distorted by this. However, I estimated that the Mexican revenue to be about USD 70 million for 2019 ie 2.7 % of the 2019 North America segment revenue. Thus, any distortion is not significant.

However, the return to the Group on a total capital basis had declined over the past 11 years following the acquisition of Sealy in 2012 as can be seen from the chart below. 

• Over the past 3 years, the EBIT/TCE averaged 19 %.  While decent, it nowhere compares to the 59% average in 2010/2011 prior to Sealy’s acquisition.

• However, there seems to be an improvement in 2020.

Chart 4: Returns

Case Notes When I first got into value investing, I focused on Bursa Malaysian companies. This was because I was familiar with the regulatory requirements. For Bursa Malaysia, the company Annual Reports provided almost all the information about the company.  These included directors' info, shareholdings, financial performance and, business outlook. It was thus natural that I looked for the US companies Annual Reports when I analyzed US companies. The first thing I found was that not all produced Annual Reports.  The US companies had different reporting formats.   The various SEC filings were different compared to those in Malaysia. You had to look at both Form 10K and Proxy Statements for the same information in the Malaysian companies' Annual Reports.  Today I want to highlight another difference - directors' info relative to the reporting year. In the Malaysian Annual Reports, the info on directors covered those who have served as directors for the year. For example, for the 2020 Annual Report, we have the information of directors who served in 2020. In the US, the Proxy Statement is for the company to formally present the past year's financials. However, the info on directors covered those to be elected. For example, the information of directors in the 2021 Proxy Statement covered the incoming directors.  In other words, it is for those serving in 2021 and not those who served in 2020.  This is another example of why being familiar with the regulatory and reporting practices in each country is important.

Case Notes

When I first got into value investing, I focused on Bursa Malaysian companies. This was because I was familiar with the regulatory requirements.

For Bursa Malaysia, the company Annual Reports provided almost all the information about the company.  These included directors' info, shareholdings, financial performance and, business outlook.

It was thus natural that I looked for the US companies Annual Reports when I analyzed US companies. The first thing I found was that not all produced Annual Reports.  The US companies had different reporting formats.  

The various SEC filings were different compared to those in Malaysia. You had to look at both Form 10K and Proxy Statements for the same information in the Malaysian companies' Annual Reports. 

Today I want to highlight another difference - directors' info relative to the reporting year.

• In the Malaysian Annual Reports, the info on directors covered those who have served as directors for the year. For example, for the 2020 Annual Report, we have the information of directors who served in 2020.

• In the US, the Proxy Statement is for the company to formally present the past year's financials. However, the info on directors covered those to be elected. For example, the information of directors in the 2021 Proxy Statement covered the incoming directors.  In other words, it is for those serving in 2021 and not those who served in 2020. 

This is another example of why being familiar with the regulatory and reporting practices in each country is important.

Is there a Rich and Unique History?

Before the acquisition of Sealy, the Group described itself as: 

“…the leading manufacturer, marketer, and distributor of premium mattresses and pillows...”

Today, the Group described itself as:

“…global bedding company that develops, manufactures and market bedding products…”

Apart from providing the Group with a quantum leap in revenue, what has the acquisition of Sealy meant for the Group?

Before the acquisition, the Group was a non-innerspring mattress manufacturer. With Sealy, the Group also became an innerspring mattress manufacturer.

Due to the acquisition and the changing market situation, the Group’s business profile has changed over the past 11 years as shown by the 2 following charts. 

From 2010 to 2012, North America accounted for about 68 % of the Group’s revenue. This has grown so that over the past 3 years, North America accounted for 83 % of the Group’s revenue.

Chart 5: Revenue by regions

The Group segments its products into 2 categories

• Bedding - mattresses, foundations, and adjustable bases.

• Others - these include pillows and other accessories.

From 2010 to 2012, Bedding accounted for about 84 % of the Group’s revenue compared to 91 % over the past 3 years.

Chart 6: Revenue by products

In terms of distribution, the Group had also re-classified its channels:

• In 2010, it reported that it sells at wholesale through 3 distinct channels - Retail, Health care, and Third Party. The Group also had a Direct channel that sells through its call centres and online.

• In 2017, the Group updated its channel focus to just Wholesale and Direct.

From 2010 to 2012, about 69 % of the revenue was derived from Wholesale. This has increased to an average of 85% over the past 3 years.

While the acquisition of Sealy has resulted in a jump in revenue, it has resulted in a lower margin for the Group.  This is because most of Sealy's products had lower margins as illustrated in the chart below. 

• In 2010 and 2011, the Group gross profit margin which was due to only Tempur-Pedic International products averaged 51 %.

• In contrast, Sealy's gross profits for 2013 and 2014 averaged 31 %.

Chart 7: Profit margins by region

Furthermore, the PBT margins for the International segment are much larger than that for North America.  From 2014 to 2020, the North America segment gross profit margin averaged 39 % compared to the average 54 % for the International segment. Note that the International segment gross profit is before the royalties. 

But, over the past 2 years, the Group has managed to improve its PBT margins for the North America segment. This was due to a combination of higher sales and higher gross profit margins.

2020 Growth

TXP revenue in 2020 grew by 18% when compared to the 2019 revenue. In contrast:

• The US Bedding industry grew marginally from USD 16.79 billion in 2019 to USD 17 billion. Source: Statista.

• The total revenue of the 4 listed benchmark US bedding companies shrunk by about 3 %. The 4 benchmark companies were Leggett & Platt, Sleep Number, La-Z-Boy, and Casper.

How much of the growth was due to acquisitions? In 2020, TXP made 2 acquisitions:

• Sherwood Bedding with an estimated annual turnover of USD 150 million. Source: TXP press release.

• Innovative Mattress Solutions following its bankruptcy filing. According to Dun and Bradstreet, the company had USD 108 million in revenue.

TPX did not provide any breakdown of the Group revenue.  But I deduced the following:

• Both these acquisitions accounted for USD 258 million of revenue in 2020.  Based on this, TPX's non-acquisition or organic growth in 2020 would be about 10.1 %.

• If you consider that these 2 acquisitions served only the US market, then the North America segment organic growth was 11.4 %. 

Irrespective of how you view the growth, TPX 2020 organic revenue growth rate is far ahead of the industry.

Is there a Great Future?

The Group has two business segments - North America and International.  Thus the industry prospects should be view from the respective market segments.

• The North American bedding market is estimated to be about USD 17 billion. This is projected to grow at a rate that is below the long-term US GDP growth rate of 4%.

• The International mattress market is about the same size as that for the US but is projected to grow at a faster rate than the US.

USA

As the USA accounted for the bulk of the North America segment revenue, I will focus on the US market.

The bedding industry is a mature market with the US bedding (mattresses and foundations) growing at a CAGR of 5.6 % from 1997 to 2017 (Source: TPX SEC filings). 

The USA market can be segmented into innerspring, memory foam, and latex products. The innerspring accounted for the majority of the sales. But, the growth potential is larger for the memory foam segment.

“The memory foam category, on the basis of product, is projected to witness the fastest growth in the U.S. mattress market during the forecast period. The rise of the direct-to-customer (DTC) model has been credited as the major driver for the shift in the market demand from innerspring to memory foam mattresses.” Prescient & Strategic Intelligence.  

Chart 8: US mattress market. Source: Mordor Intelligence 

Forward projection from several market research groups put the industry growth below the long-term USA GDP growth of 4 %.

• The 2019 US mattress market was about USD 15.7 billion and is projected to increase at a CAGR of 3.5 % from 2020 to 2030.  Source: Prescient & Strategic Intelligence.

• The US mattress market is expected to grow annually by 2.4% from 2021-2025. Source: Statista

But I have another perspective of the growth potential. There is a 0.93 correlation between the USA Housing Starts and the North America segment revenue.  

Over the past 11 years, the US Housing Starts grew at a CAGR of 8.9 %. Over the past 10 years, the average US Housing Starts was about 1/3 below the past 6 decades average. Over the past 6 decades, the US Housing Starts have averaged about 1.5 million units annually.  

If this correlation continues to hold, it would augur well for TPX as the Housing Starts has been on an uptrend over the past decade. 

At this level of Housing Starts, TPX North America segment revenue would be about 46% higher than its past 11 years’ average revenue. This indeed very significant and can provide a short-term boost to TPX.

There is another positive sign for TPX.  According to the International Sleep Products Association, the mattress replacement period among residential end-users has reduced to 6–8 years. This is projected to increase the demand for mattresses.

The US mattress industry is dominated by a few key players. 

• Serta Simmons leads the innerspring mattress market. Source: Prescient & Strategic Intelligence.

• The industry is largely controlled by two mattress manufacturing giants. Those with the largest market share include TPX, Serta Simmons, Sleep Number, and Casper Sleep. Source: IBIS World

• The US mattress manufacturing industry includes about 420 establishments with combined annual revenue of about USD 8 billion. Source: Dun & Bradstreet. Compare this to the USD 5 million in 2011. Source: TPX.

International

Based on a number of market research reports, I estimated that the non-USA mattress market is about the same size as the US market. 

• According to Statista, the global mattress market is expected to grow from about USD 30 billion in 2019 to over USD 43 billion by 2024. This is equivalent to a CAGR of 7.4 %.

• Fortune Business Insights puts the global mattress market size at USD 30.38 billion in 2019 and projected it to grow to USD 40.37 billion by 2027, equivalent to a CAGR of 4.2 %.

• The global mattress market reached a value of USD 30.3 billion in 2019 and is projected to reach USD 44.0 billion by 2025, at a CAGR of 6.2% during 2020-2025. Source: Research and Markets.

I deduced that the non-US mattress market would grow at a faster rate than the US mattress market.  It would appear that the innerspring mattress also dominated the global market.

Chart 9: Global mattress market.  Source: Fortune Business Insights

Conclusion?  

The US is a mature market.  However, there are short-term growth opportunities.  But this will not provide TPX with a quantum leap in organic growth over the long term. However, it can provide growth at the long-term GDP rate.  

Given Sealy’s innerspring technologies and the faster growing non-US market, there are opportunities for TPX to further expand its International segment.

Anti-dumping

In 2020, the US Department of Commerce and the US International Trade Commission imposed anti-dumping duties on a number of countries that were exporting mattresses to the US. These included China, Turkey, and few ASEAN countries. 

Collectively these countries exported about USD 570 million of mattresses in 2019. (Source: US Dept of Commerce April 2020). The curtailment of these imports will provide short-term replacement opportunities for US mattress companies. 

Pulling it all together

Given its growth history and its recent performance, you may think that TPX is a growth stock. My investment thesis is that TPX could be a growth trap.

This can only confirm after a valuation of TPX.  But at this stage, I have shown that:

• In the past 3 years, EBIT/TCE employed averaged 19%.  As I will show in Part 2, this is above the cost of funds.

• This is not a sunset industry. Its two business segments - North America and International - still have organic growth prospects. 

• The Group is one of the top 2 industry leaders in the US market.  

• The industry growth in the US seemed to have been driven by the growth in the Housing Starts. But this is not long-term sustainable growth. 

• It has both innerspring and memory foam mattress expertise in line with market demand. 

End of Part 1 of 2

Part 2 of 2 was published on 23 May 2021

Reading guide

If you are a first-time visitor to this blog, you may not be familiar with some of the concepts that I have used in my analysis and valuation.  I suggest that you check up the Foundations series - Fundamentals 01,  Fundamentals 02, and Fundamentals 03.   I also have a Definitions page in case you are not familiar with the terms I have used. 

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Disclaimer & Disclosure

I am not an investment adviser, security analyst, or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.

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