Mattresses Are a Great Place to Be for a Housing Rebound

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: This article has been amended to better reflect Sleep Number's DualTemp product.

One of the best ways to play the housing rebound is to look at other sectors that will benefit as more homes are sold. When buyers purchase new homes, typically they need furniture to go with it. And of course, with that furniture a new mattress is a must. Typically, home buyers are very particular about where they purchase their mattresses and the type of mattresses they want. Every person has their own unique needs, and these three mattress stocks look like the places to be.

The store for mattresses

Investors in Mattress Firm (NASDAQ: MFRM) are seeing a boost after the company reported a stellar earnings report. Sales jumped 31.5% to $276 million and earnings rose 23.3% compared to last year. The company's growth strategy continues to pay off for shareholders.

Last year, Mattress Firm acquired 180 Mattress Giant stores, 34 Mattress Express stores, 27 Mattress Source stores, and opened 46 new flagship stores. Mattress Firm now has 1,096 company-owned stores and is on pace for its third consecutive year of opening at least 100 new stores.

In breaking down the company's revenue, 47% came from the sale of specialty mattresses and 44% came from the sale of conventional innerspring mattresses. The balance came from the sale of furniture, accessories and delivery fees.

Mattress Firm has consolidated the mattress sector and its shareholders have been rewarded. After the earnings announcement, the stock hit a new 52-week high and shares are up more than 36% in the past year.

According to an analyst report from Piper Jaffray, there are three key items to drive growth for Mattress Firm this year:

Mattress manufacturers have launched a slew of new products and have stepped up national advertising to support those products; The acquired Mattress Giant stores will be accretive to comparable and gross margins; Product margin expansion is trending higher with an increase in the first quarter year-over-year by 110 basis points.

All three items will boost both the top and bottom lines for Mattress Firm over the next several quarters.

The mattress industry

The other two main players in the mattress industry are Tempur Sealy (NYSE: TPX) and Select Comfort (NASDAQ: SCSS). Tempur Sealy competes with Mattress Firm in both the segments of the market – the high end and the low end. The acquisition of Sealy by Tempur-Pedic brought together Sealy's lower-end mattresses with the high-end Tempur-Pedic line. Select Comfort is the primary competitor to Mattress Firm in the air-filled mattress market.

It's also important to note that Mattress Firm sells Tempur-Pedic and Sealy mattresses in its stores. So even though the two companies do compete for the end buyer, they also have a symbiotic relationship and need to work together. Mattress Firm is a prime retail outlet for Tempur Sealy's mattresses.

The combination of Tempur-Pedic and Sealy created a formidable player in the mattress industry. The combined entity is expected to save $40 million per year. This will allow Tempur Sealy to increase margins and deliver results to the bottom line.

The downside to the merger is that the combined company is saddled with $2 billion in debt. Considering that Tempur Sealy has a market cap of $2.7 billion, this a little bit more debt than I would like on the balance sheet. The focus at Tempur Sealy needs to be on reducing costs and paying down debt. Luckily, mattresses are a high margin business and Tempur Sealy can do that as long as the economy continues to recover and remain strong.

Select Comfort sells its mattresses under the Sleep Number brand. The Sleep Number mattresses are designed around customers' unique sleep preferences. Each mattress can be adjusted with the touch of a button for individual firmness and support. Select Comfort sells its mattresses at 400 Sleep Number stores and online. The target market for Select Comfort is the upper-income individual who is particularly health conscious and desires the best sleep possible. 

The company just introduced technology that allows each side of the bed to be temperature controlled. Each side can be individually heated and cooled. According to another analyst report from Piper Jaffray, the new DualTemp layer could boost comparable store sales by 2% to 4%. Piper Jaffray also did store visits over the busy Memorial Day weekend and said the new DualTemp product was selling well. I see the DualTemp layer boosting sales for Select Comfort and agree with Piper Jaffray's analysis.

I like how Select Comfort is managed. The company has $142.7 million in cash and no debt, and it has the highest gross margins in the industry. The forward P/E is 13.8 and the PEG ratio is just above 1 at about 1.1. The return on equity is an impressive 42.6%. From a valuation perspective, Select Comfort is the cheapest among the mattress stocks.

How they all compare

<table> <tbody> <tr> <td> </td> <td> <p><strong>Mattress Firm</strong></p> </td> <td> <p><strong>Tempur Sealy</strong></p> </td> <td> <p><strong>Select Comfort</strong></p> </td> </tr> <tr> <td> <p><strong>Market Cap</strong></p> </td> <td> <p><span><span>$1.3 billion</span></span></p> </td> <td> <p><span><span>$2.5 billion</span></span></p> </td> <td> <p><span><span>$1.2 billion</span></span></p> </td> </tr> <tr> <td> <p><strong>Revenue</strong></p> </td> <td> <p><span><span>$1.0 billion</span></span></p> </td> <td> <p><span><span>$1.4 billion</span></span></p> </td> <td> <p><span><span>$930.8 million</span></span></p> </td> </tr> <tr> <td> <p><strong>Gross Margin</strong></p> </td> <td> <p><span><span>0.5</span></span></p> </td> <td> <p><span><span>0.5</span></span></p> </td> <td> <p><span><span>0.6</span></span></p> </td> </tr> <tr> <td> <p><strong>EBITDA</strong></p> </td> <td> <p><span><span>$115.5 million</span></span></p> </td> <td> <p><span><span>$269.3 million</span></span></p> </td> <td> <p><span><span>$143.3 million</span></span></p> </td> </tr> <tr> <td> <p><strong>Operating Margin</strong></p> </td> <td> <p><span><span>0.1</span></span></p> </td> <td> <p><span><span>0.2</span></span></p> </td> <td> <p><span><span>0.1</span></span></p> </td> </tr> <tr> <td> <p><span><span><strong>Net Income</strong></span></span></p> </td> <td> <p><span><span>$39.9 million</span></span></p> </td> <td> <p><span><span>$63.1 million</span></span></p> </td> <td> <p><span><span>$79.1 million</span></span></p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p><span><span>33.6</span></span></p> </td> <td> <p><span><span>41.0</span></span></p> </td> <td> <p><span><span>15.4</span></span></p> </td> </tr> <tr> <td> <p><strong>PEG Ratio</strong></p> </td> <td> <p><span><span>0.8</span></span></p> </td> <td> <p><span><span>1.2</span></span></p> </td> <td> <p><span><span>1.1</span></span></p> </td> </tr> </tbody> </table>

Judging from this table, we see that Mattress Firm has the best valuation based on the PEG ratio. Select Comfort has the lowest P/E among the three and the highest gross margin. Tempur Sealy has the highest operating margin.

Foolish assessment

The mattress industry is closely watching the housing sector. As the housing industry continues to recover, look for mattress sales to be firm and their stock prices to closely track the data on housing.

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Mark Yagalla has no position in any stocks mentioned. The Motley Fool owns shares of Tempur-Pedic International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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