Is Tempur-Pedic a Buy? Or is Select Comfort Still the Best Choice?

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

It seems like so long ago that Tempur-Pedic (NYSE: TPX) CEO Mark Sarvary cut bottom line guidance in half along with an estimated sales decline of 3-5% for the remainder of the year. But in fact, it has been almost six months, and although the stock is still trading with a near 60% loss since April, it has recently recovered with a 40% gain during the last three months. Therefore, with its metrics looking Foolishly attractive, is it now time to buy? Or is TPX still a “second best” in the space?

I think to get a clear picture of this company, its valuation, and its performance over the last year, you must first look at the events that led to its decline. During the two years prior to April, Sarvary had constantly reaffirmed and raised the earnings guidance for TPX. The company had been one of the better fundamental performers since the recession, with its stock rallying from under $4.50 to nearly $90 in a period of just three years. However, its steep decline was a result of management, and their inability to “predict” the changes in competition and demand within their own industry. As a result, a lot of investors got hurt, and honestly, I just can’t trust this management.

If you take a look at the fundamentals compared to valuation of this company it looks to be an automatic buy. The lower guidance that cut the stock’s price in half has recently been revised (once more) and the company now expects earnings per share of $2.80. The company also recently announced its plan to acquire Sealy Corp to create a $2.7 billion global bedding provider. Therefore its 40% three month gain is logical and the stock is now a definite buy, right? I don’t think so.

There is a good chance that you could buy TPX and return large gains for many years to come. However, management has already proven that they cannot take into account the changes in the economy. And with such uncertainty in the global economy, I prefer a more expensive, but a better company in Select Comfort (NASDAQ: SCSS).

When you look at the two companies, Tempur-Pedic and Select Comfort, side-by-side, there are several similarities but also several differences. First off, Select Comfort has not cut its guidance in half. In fact, it has raised guidance from $1.32-$1.40 to $1.35-$1.41, showing that it has a good grasp on the supply and demand of the industry. The company’s valuation was also negatively affected by the fall of TPX, and therefore its fundamentals and valuation have become more attractive as an investment. Other than consistent guidance, and a stock that has rallied from $0.20 to over $30 since the recession, it’s still expecting growth in North America, while Tempur-Pedic expects a decline. Tempur-Pedic blamed much of its decline on Europe, however Select Comfort is unexposed to Europe. Select Comfort sells a portion of its products at its own stores, rather than relying solely on third-party providers. Tempur-Pedic does not have its own stores, and is sold only in third-party stores, therefore has less control of its products. Overall, looking at both companies as a long-term investment, I think SCSS is the clear winner. However, there is one more area to discuss, and that is the valuation. Take a look at how the two companies compare:

 

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>TPX</p> </td> <td> <p>SCSS</p> </td> </tr> <tr> <td> <p>Market Cap (billions)</p> </td> <td> <p>$2.04</p> </td> <td> <p>$1.87</p> </td> </tr> <tr> <td> <p>Trailing P/E</p> </td> <td> <p>11.16</p> </td> <td> <p>26.38</p> </td> </tr> <tr> <td> <p>Forward P/E</p> </td> <td> <p>11.00</p> </td> <td> <p>18.16</p> </td> </tr> <tr> <td> <p>Price/Sales</p> </td> <td> <p>1.32</p> </td> <td> <p>2.18</p> </td> </tr> <tr> <td> <p>Profit Margin</p> </td> <td> <p>13.91%</p> </td> <td> <p>8.41%</p> </td> </tr> <tr> <td> <p>Operating Margin</p> </td> <td> <p>21.59%</p> </td> <td> <p>13.10%</p> </td> </tr> <tr> <td> <p>Return Assets</p> </td> <td> <p>23.69%</p> </td> <td> <p>28.76%</p> </td> </tr> <tr> <td> <p>Return Equity</p> </td> <td> <p>364.16%</p> </td> <td> <p>55.66%</p> </td> </tr> <tr> <td> <p>Cash (millions)</p> </td> <td> <p>$134.20</p> </td> <td> <p>$123.10</p> </td> </tr> <tr> <td> <p>Total Debt</p> </td> <td> <p>$683.71 million</p> </td> <td> <p>$200,000</p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p> </p> </td> <td> <p> </p> </td> </tr> </tbody> </table>

 

Retail investors place too much emphasis on a “P/E ratio” and although it’s important it doesn’t tell the whole story. Obviously, TPX is cheaper compared to fundamentals over the last 12 months. It has a more attractive P/E ratio, forward ratio, and price/sales. However, it also has reached a peak with margins, while Select Comfort is not even close. Both companies have similar cash, yet TPX has a heavy debt burden, while SCSS trades with minimum debt. I view this as just another reason that SCSS management is more effective, and why SCSS is worth the premium. But aside from management and balance sheet concerns, take a look at the growth of both companies, based on the most recent quarter year-over-year.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>TPX</p> </td> <td> <p>SCSS</p> </td> </tr> <tr> <td> <p>Revenue Growth</p> </td> <td> <p>(3.7%)</p> </td> <td> <p>27.10%</p> </td> </tr> <tr> <td> <p>Net Income Growth</p> </td> <td> <p>(45%)</p> </td> <td> <p>50.30%</p> </td> </tr> </tbody> </table>

 

When you take all things into consideration it’s obvious why SCSS trades with a higher premium, because it’s worth it. Tempur-Pedic is not growing, meanwhile Select Comfort is not only growing aggressively, but also improving its margins. As we move forward it’s possible that TPX will perform better than SCSS, but as a long-term investment, I feel as though SCSS is the better and safer play, because I simply don’t trust the management of Tempur-Pedic to deliver, especially with such a heavy debt burden. As a result, I do believe that Tempur-Pedic may have deserved its 40% rally during the last three months following its key developments. However, it does appear that the market agrees with me, as Select Comfort has rallied by 53% in the same period, which shows that SCSS will most likely trade higher to the same degree as TPX, along with being the better company. 


BrianNichols has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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