On Dec. 3, mattress and accessory retailer Mattress Firm
(NASDAQ: MFRM) came out with its Q3 2014
quarterly
statement. The company performed well on the top line front but not so much
on the profitability front. Let’s see what’s going on with this company.
Robust top line gains
Mattress Firm’s year-to-date revenue gained $303 million
dollars representing a 33.5% year-over-year increase in revenue overall. Mattress’s
Firm’s entire product and service portfolio saw gains in revenue (see table
below). Conventional mattresses made up the largest percentage (48%) of overall
gains with this segment increasing $145.8 million or 35% year-over-year.
|
Sales by Product
|
|
|
YTD 10/28/14
|
YTD 10/29/13
|
Gain
|
Gain as % of Total
|
YOY Gain
|
|
Conventional Mattresses
|
$567.6
|
$421.8
|
$145.8
|
48.1%
|
34.6%
|
|
Specialty Mattresses
|
$525.7
|
$403.5
|
$122.2
|
40.3%
|
30.3%
|
|
Furniture and accessories
|
$91.4
|
$62.6
|
$28.8
|
9.5%
|
46.0%
|
|
Delivery service revenue
|
$23.0
|
$16.8
|
$6.2
|
2.0%
|
36.9%
|
|
Total
|
$1,207.7
|
$904.7
|
$303.0
|
100.0%
|
33.5%
|
Source: SEC filings and author’s calculations
Organic sources contributed 63.1% to Mattress Firm’s overall
gains meaning that the company can grow its top line by bringing customers
through the door rather than by simply buying other companies (see table
below). Established stores contributed a respectable 22% to the overall gain in
Mattress Firm’s year-to-date revenue while expansion contributed another 41%. Acquisitions,
however, did account for the remaining 42% of year-to-date revenue gains.
|
Type of Gain
|
Change in sales
|
% of Total Gain
|
|
Comparable store sales
|
$67.5
|
22.3%
|
|
New stores
|
$123.7
|
40.8%
|
|
Acquired stores
|
$126.1
|
41.6%
|
|
Closed stores
|
-$14.3
|
-4.7%
|
|
Total YTD YOY Gain in Sales
|
$303.0
|
100.0%
|
Source SEC filings and author’s calculations
Net income declined
Mattress Firm’s net income declined 15% year-over-year.
Relatively higher general and administrative expenses tied to acquisitions
contributed heavily to the decline in net income. Increased interest expense
stemming from accumulation of long-term debt also contributed to net income
decline.
Free cash flow
declined
Mattress Firm’s year-to-date free cash flow also declined
17% vs. the same time last year. Capital expenditures increased 33% due to
increased opening of new stores relative to last year. Hopefully, the investment
in expansion will pay off in the long run.
How does this fit
into the overall picture?
Mattress Firm has grown its revenue, net income, and free
cash flow a healthy 207%, 13,000%, and 184% respectively and translating into a
total return of 163% vs. 80% for the total return S&P 500 according to Y Charts.
The company has
expanded
at a fast pace going from 487 locations in 2009 to 1,986 locations in the most
recent quarter. It should be noted that comparable store sales have declined
steadily in the past three years. Hopefully, this trend will reverse itself
this year.
Lousy balance sheet
Mattress Firm possesses a lousy balance sheet. Its $5
million cash balance equates to a mere 1% of stockholder’s equity, way below my
personal threshold of 20%. Companies that harbor plenty of cash can get themselves
through tough times, self-finance acquisitions and invest in product
innovation.
Mattress Firm also expanded its long-term debt to finance
acquisitions. Long-term debt increased to $750 million vs. $216 million at the
start of the year, expanding its long-term debt to equity ratio to 178% vs. 66%
which vastly exceeds my personal threshold of 50%. Long-term debt creates
interest expense which serves as drag on profitability. So far this year, Mattress
Firm’s operating income exceeds interest expense by seven times vs. 10 times
the same time last year. The rule of thumb for safety lies at five times or
more.
Looking ahead
Mattress Firm’s massive expansion of long-term debt gives
indication that the company may be expanding too fast. Also, the company trades
at a high P/E ratio of 43 vs. 19 for the S&P 500, according to Morningstar.
A market correction could severely impact this company’s stock price. Management
lowered its guidance and expects earnings per share to be between $1.44 and
$1.50 for its FY 2015. If the companies misses that estimate and clocks in at say
$1.43 per share, assigning a normal multiple of 23, puts the company stock
price at $32.89 per share which represents a 42% downside from its current
price. Even at $1.50 a multiple of 23 would translate into a share price of
$34.50, or a 39% downside.
Investors may want to consider more solid
companies such as Union
Pacific which offers a more reasonable valuation of 22.
DISCLOSURE: STOCKDISSECTOR (William Bias) owns shares of Union Pacific and will not trade the stock for three market days.
