Sleep Number: Don’t Sleep On This Stock (NASDAQ:SNBR)


Sleep Number Corporation (SNBR) was founded in 1987 under a name that is more familiar to many of us, Select Comfort Corporation. While the company still, as its name would suggest, sells mattresses and other bedding products, Sleep Number bears almost no resemblance to the original company. In 2012, the company appointed Shelly Ibach as CEO and president. Since that time, it has transformed itself from a struggling mattress company to a profitable enterprise that is as much a technology company as a mattress maker. Today, Sleep Number operates 610 stores in 50 states, has a growing digital presence, and sports a market cap of $1.75 billion.

Image Source: Sleep Number

Buy at the High?

Sleep Number hit an all-time high last Thursday after obliterating analysts’ estimates with quarterly earnings of $1.79 per share. This was not just a beat, it was a shellacking. The company beat expectations by 68%, which marks the third quarter in a row in which it has surpassed expectations by at least 32%. Of course, the share price responded in kind, jumping 11% on the day of the report even after almost quadrupling from its March lows.

The obvious question now is whether Sleep Number still deserves your attention as an investor or whether we are a day late and a dollar short on this stock. In the balance of the article, we will take a little deeper dive and I will explain why I believe Sleep Number is a buy even after hitting all-time highs.

Where’s the Love?

While I have already stated that I think the stock is a buy, it is clear that not everybody agrees. According to the Wall Street Journal, the five analysts following the stock have an average price target of $53.25, which would represent an 18% haircut from the current price. In addition, the short interest is currently 17% of the company’s float, which certainly is on the bearish end of the spectrum.

Current Valuation

We’ll start with the fact that analysts are expecting full-year earnings to come in at $4.08. At the current share price, that would imply a P/E of 15.47. As the top segment of the chart shows, the 5-year median P/E of Sleep Number is 20.62, which means the stock is trading at a discount to its historical valuation. The second and third segments of the chart show that not only does Sleep Number trade at a discount to its historical range, it also trades at a discount to its peers. The only company that even comes close is Tempur Sealy (TPX), but Sleep Number still comes out looking cheaper in a head-to-head matchup.

Valuation Measures of Mattress Companies

ChartData by YCharts

The valuation discount, coupled with a solid balance sheet, combines to make the high short interest a little puzzling. When we look at Sleep Number’s Debt-to-Equity numbers in comparison to Tempur Sealy, they look pretty good. The Cash from Operations number looks good in comparison as well when we consider the fact that Sleep Number carries a market cap about one-third the value of TPX.

Cash and Debt Metrics for Sleep Number and Competitor

ChartData by YCharts

What Sets It Apart?

With any company, it pays to ask the question, “What sets them apart from the competition?” Can anybody do what they are doing? Ibach would respond with a resounding “No” to the second question, and in fact, stated that the company is currently accelerating its competitive advantages. The competitive advantages, according to management, are basically two. First, Sleep Number is the only mattress company out there that operates exclusively in a direct-to-consumer framework.

The second advantage has to do with science and technology. That is not to say other mattress companies like Temper Sealy haven’t upped their game in that area as well – they have. However, Sleep Number seems to have taken mattress science and technology to another level. The company has analyzed nearly eight billion hours of longitudinal sleep and biometric data in an effort to perfect its sleep science innovations. Sleep Number 360 creates its own microclimate by warming your feet and first and then balancing surface temperature throughout the night. More impressively, upcoming launches will get into circadian rhythm insights, personalized sleep wellness reports, and heart rate variability.

Efficient Operation

Sleep Number has been getting more efficient in recent years. The chart below highlights improvement trends in margins, and the company has received recognition as “Supply Chain to Admire” two years in a row.

Sleep Number Margin Trends

ChartData by YCharts

Management Swagger and Optimism

I have listened to a lot of earnings calls in the last twenty years, and I can comfortably say I cannot remember a management team more confident than this one. In the Q&A portion, there were several instances of management interrupting other management members to throw in additional reasons for optimism. Here are a few comments from management on the call that exemplify that optimism:

Our pursuit of breakthrough performance and the momentum of our initiatives provide confidence in the compelling value creation yet to come.

We are bullish on our path forward

We also see tremendous value in our stock

And we’re so bullish on the initiatives that we have in place and our ability to continue to drive growth quarter after quarter and year after year.

The chart below shows that management has been consistently increasing its research & development investments in recent years. Management vows to continue to do so, and those investments seem to be paying off. As Seeking Alpha Contributor In the Ruff Research noted that Sleep Number has been increasing market share at a significant clip lately. Ibach echoed that sentiment saying, “We’ve taken share for over four years and absolutely continue to believe we’re taking share, and we’ll take share this year.”

Sleep Number Research and Development Spend

ChartData by YCharts

Caution Flags

There are a few caution flags, but I don’t believe valuation or risk to market share is amongst them. Here are a few caution flags as I see them, and if they are strong enough to keep you out of the stock, so be it.

First, the pandemic is worth mentioning. The second quarter was painful, and if we get to a place where COVID-19-related restrictions ramp up again, it will affect revenue in the short term. Secondly, these mattresses aren’t cheap, and they last a long time. One could surmise at some point, most of the folk who can afford these mattresses will already own one and it will have shelf life remaining. In short, high-end mattress sales could be cyclical. Finally, the supply chain survived, but it was stressed in the last year. Any break in the supply chain could slow down growth initiatives.

Conclusion

Well, I buried the lede a long time ago. I believe Sleep Number provides a good value proposition. Here are my numbers.

The average analyst estimate four years from now is $5.46. While that may prove conservative, I’ll run with it. Applying a 2024 EPS of $5.46 and a P/E of 18 yields us a 2024 stock price of $98.28. Those numbers represent a 56% gain from today’s closing price of $63.

With the recent run-up, there could be some profit-taking in the near term. As an investor, however, I am not really concerned with the next 3-5 days or 3-5 weeks. I am focused on performance over the next 3-5 years. In my opinion, short-term pullback or not, this stock is a buy at $63 for anyone with a 3-5 year time horizon.

Disclosure: I am/we are long SNBR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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