Tuesday, June 5, 2007

Select Comfort: Great Company and Great Price

Select Comfort is an upscale vertically integrated mattress and other sleep accessories designer, manufacturer, marketer and retailer. Their mattresses are marketed under the Sleep Number brand name and based on their proprietary air-chamber technology which adjusts the softness of the bed with the touch of a button. The bed’s two sides adjust separately from each other which increase each partner’s experience. Their beds are clinically proven to provide people who sleep on their mattresses better sleep than people who sleep on the traditional innerspring mattresses.

Select Comfort is a Minnesota based corporation which was founded in 1987. They were ranked as the 6th largest mattress manufacturer in 2005 according to Furniture/Today. At that point, they held a 5% market share of industry revenue and a 2% market share of industry units.

They run a lean inventory system with most of the mattresses manufactured after a purchase. Their inventory on hand is minimal. They are currently working on dual sourcing suppliers because their proprietary parts are mostly made by one manufacturer. This will help Select Comfort continue normal business operations if something happened to their main suppliers.

Industry


The mattress industry is stable and mature. It has been growing steadily. Over the past 20 years, the annual growth rate for U.S. wholesale bedding shipments is 6.8%. It is a very competitive and fragmented industry. There are also a wide variety of government regulations. The main competitors for air-bed products consist of Simmons and Sealy. Their largest competitors from the innerspring mattresses consist of Sealy, Serta, Simmons and Spring Air.

Select Comfort will benefit from the health mega trend and the aging of baby boomers mega trend. People will want better mattresses that will help them with a better sleeping experience. This in turn will help people be more productive during the day.

Company

Select Comfort makes some of the most expensive mattresses on the market, with prices averaging from $900 to $4,000 per mattress. They offer a 20 year warranty on all of their brand new Sleep Number mattresses. There is an exclusive Comfort Club for members who have purchased Sleep Number beds through company owned channels, members are provided with gifts if they refer someone to purchase a mattress. Select Comfort also provides a Home Delivery Service, which offers delivery, assembly and mattress removal services to improve the total customer experience, with the purchase of their mattress. Over 90% of their sales come from their three company owned distribution channels, retail, direct and e-commerce. Wholesale and e-commerce have been the two fastest growing channels; they are the only two channels that grew in the 1st quarter compared to the same time period in 2006. Select Comfort consistently spends over 40% on Sales and Marketing expenses. They have been working on expanding their presence in other retailers, they currently have 841 stores that carry their products. With all of this extra retail exposure, will it dilute their brand? Historically they have sold only through company controlled channels. Select Comfort has partnership agreements with Winnebago and Radisson Hotels to help promote their brand.

Valuation

SCSS is currently trading at a trailing p/e ratio of 21.43 and a forward p/e ratio for 2008 of 15.02. Their PEG ratio is .9. Their current ratio is .897, which is troublesome. Their balance sheet is solid, no debt and $66.8 million in cash and investments. 9.2% of the company is owned by insiders. Their accounts receivable rose significantly in 2006 compared to 2005, accounts receivable turnover decreased from over 110 times in 2005 to just over 66 times in 2006. They have been actively repurchasing their shares and shrinking the share count going from 59,252 outstanding diluted shares in 2004 to 51,798 outstanding diluted shares as of last quarter. Select Comfort just authorized an additional $250 million of share repurchases for a current total of $290 million. Their Capital Expenditures are a significant use of their cash, they had expenses of $31 million in 2006, $26 million in 2005 and $21 million in 2004. Their CAPEX are mostly due to their retail store openings and as of recently, for their SAP implementation. Nevertheless, they still provided Free Cash Flow of $28 million, $62 million and $31 million in the past 3 years. SCSS is owned by Ron Baron, who is a famous growth investor. He mostly invests in small and medium size growth companies. This was a top 50 Magic Formula Stock with a market cap bigger than $100 million as of 6/3/2007.

Technicals

It is currently trading at around $18 a share. The long-term trend is down, the short-term trend is up and the medium-term trend is neutral. It just recently crossed above the 20DMA and the 50DMA. It is still below the 200DMA. The $17 level is proving to be a very strong support level. It’s been trading between $17 and $20 a share in the past 6 months. MACD and RSI are both showing a positive divergence. Both of them are trending up while the stock has been stuck in the range. Volume is also showing a positive divergence with the On Balance Volume in an uptrend. All three indicators are showing positive signs, but the stock is still stuck in its range and not trading above its three major moving averages. This bears watching, it could be due for a breakout with volume accumulating in bullish hands.



Conclusion

Select Comfort operates in a mature and stable market with solid growth. They are a narrow-scope differentiator and they know what they are, they do not try to be everything to everyone. Management expected 2007 to be challenging for their company, but they still managed to beat 1st quarter analyst estimates. Their outlook for 2007 is earnings between $1.02 and $1.09 per share. Currently, the analysts estimate $1.00 a share. The resignation of J. Douglas Collier, who was their Chief Marketing Officer, should not be a problem since he was there for a very short time. The recent drop of stock price is due to the prospects of a challenging 2007 and their struggles late in 2006.

There is a lot to like about Select Comfort, their product, cash flows, management, growth and the price. I will be keeping a VERY close eye on it.

Disclosure:
I don’t have a position in SCSS.

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