Tempur Sealy Stock: Focus On FY24 Growth Potential (NYSE:TPX)

Overview

I hold a favourable view on Tempur Sealy International (NYSE:TPX) ability to execute and gain share in the bedding industry. The key thing to note is the possible short-term volatility in the stock price as the expected weak performance hits the P&L. To highlight, I think the management’s expectation of flat units for the FY23 is reasonable, despite the big drop from last year. I believe consumers will continue to hold off on major purchases until they feel more secure in their financial situation. That said, as a long-term investor, I am looking past this expected weak near-term performance, paying attention to the growth in FY24. My view is reinforced when I saw a possible stabilization in demand, commodity cost pressure easing, and management strong execution on its strategic initiatives, all of which should lead to growth and margin expansion.

Earnings update

TPX’s adjusted EPS for 4Q22 was $0.54, which was higher than consensus estimates of $0.52. EBIT margin was also 198 bps higher than expected, which drove the outperformance. However, this was mitigated to some extent by the decline in revenues and a general increase in costs below the operating line. Overall, I believe that 4Q22 results demonstrate the effectiveness of the company’s specific strategies for managing declining demand, as well as the advantage of having a varied range of products and brands. For 2023, management guided to sales growth in the low to mid single digits, translating to EPS of $2.70 at the midpoint, below the consensus estimate of $2.76.

Demand profile stabilizing

Sales in the industry continued to be lackluster during the quarter, and for the year as a whole, due to consumers’ reaction to the uncertain macroeconomic climate and the pull-forward that occurred during the pandemic. However, despite an expected recession in FY23, it is encouraging to hear management saying that industry volumes will remain relatively stable, with growth resuming in FY24. With this outlook, I expect TPX to experience sequential growth throughout the course of the year, with the first quarter’s comparisons being the toughest and getting easier thereafter.

Margins

In my opinion, commodity inflation across the board seems to be easing to the benefit of TPX, while persisting in others. Despite the positive impact this will have in 2023, prices are still anticipated to remain higher than they were in 2018. However, I anticipate further margin benefits from stabilizing supply chains, in addition to advancements in OEM operations. To that end, the Crawfordsville foam pouring plant is expected to begin operations in the 2Q23, which should further improve TPX underlying cost structure. Since the first quarter is when most investments and cost take place, I expect it to generate the lowest profit margins (i.e., the transitionary quarter) in FY23. Going forward from the first quarter, profits should gradually rise, with a significant increase in the second half of the year. This is primarily due to the expected allocation of $500 million worth of full-year advertising investments, which will mainly occur in the first half, combined with improved efficiency in overhead costs.

Strategic initiatives progressing well

My impression after reviewing TPX’s 4Q22 earnings report is that the company’s efforts will continue to enable strong performance going forward. In particular, despite a weaker demand backdrop, TPX is reaping the benefits of investments in new products and marketing. Furthermore, TPX is making use of its omnichannel distribution model to give customers more flexibility in choosing where to make purchases. On the other hand, TPX OEM operations are being expanded by management which should generate $600 million annually in revenue. As a result, despite global macro uncertainty, I expect US demand to stabilize after suffering its largest annual decline. Further, I anticipate that as we get back to a normal environment, and TPX implements these strategies, it will be able to generate robust FCF, which can be used to fund share repurchases.

Product and brand-related initiatives are also gaining traction. There has been a brisk demand for Stearns & Foster’s new offerings since the launch began. Supply chain issues have delayed the full rollout until Memorial Day, but the plan to increase available retail slots is still on schedule. More recently established e-commerce platforms also outperformed projections, largely as a result of a shift in product mix toward higher-priced items. In the coming quarters, I foresee new product launches to international markets, which will increase TPX TAM. This is a key indicator to track because it shows how transportable the TPX brand and product are and lengthens the company’s growth runway.

Conclusion

I have a favorable view on TPX’s ability to perform well and increase its market presence in the bedding industry. I consider the management’s forecast of stable unit sales for FY23 to be reasonable, as consumers may continue to delay big purchases until they feel more financially secure. As a long-term investor, I am ignoring the expected temporary weak performance and focusing on the growth prospects in FY24. My confidence in this view is strengthened by stabilizing demand, reducing commodity cost pressure, and the company’s successful execution of strategic plans, which should result in growth and improvement in margins. TPX’s 4Q22 results show the company’s ability to handle decreasing demand and the advantage of its diverse product and brand portfolio. I anticipate TPX to experience growth gradually throughout the year, with a significant increase in the latter half, due to the full-year advertising investments and improved efficiency in overhead costs. I believe that TPX is in a strong position for future growth and success.