A Trend to Watch in the Mattress Industry

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Earlier this week, when the Dow was lower by almost 200 points, Mattress Firm Holding (NASDAQ: MFRM) was trading higher by almost 7%. The stock’s strong gains led to new 52-week highs and were possible due to earnings that beat expectations.

In the quarter, Mattress Firm Holding's revenue grew 31.5% or $276 million. The company slightly beat on both top and bottom lines and also reiterated full-year guidance. The company’s impressive growth reflects "incremental sales from new and acquired stores,” as 46 new stores were opened during the quarter and the company continues to integrate Mattress Giant stores into sales. 

A not-so-good trend

At first glance, Mattress Firm Holding’s quarter looks like a home run. Even Piper Jaffray’s Peter Keith upped his price target to $48 from $40 citing “improved industry trends.” However, I am not sure how Keith arrived at his conclusion: The company’s comparable store sales actually declined by 5.2% year-over-year.

In various articles, I have explained that when assessing retail, comp sales are most pertinent as falling comps equal falling margins, which lead to inefficiency. When comp sales are rising, margins are expanding, it proves that more customers are coming into the stores. This was evident with Mattress Firm Holding as its operating margin fell 50 basis points to 8.6%, which is significantly lower than its 8.93% operating margin over the last 12 months.

In the quarterly report, Mattress Firm stated that comps grew in May and that its acquisition of Mattress Giant is “looking good.” However, I don’t see this as a lasting trend. The company also cites falling unit prices for mattresses and weak consumer traffic. These areas of concern have led to declining comps, and are a definite reason for long-term concern.

Upside in the industry?

Due to declines in traffic, I would not touch Mattress Firm as an investment, but I also wouldn’t touch Tempur Sealy (NYSE: TPX) -- and I’ll have to see about Select Comfort (NASDAQ: SCSS). Both stocks traded with nice intraday gains following Mattress Firm’s quarterly report – yet margins and consumer traffic remain an issue.

Prior to 2012, Tempur Sealy had seen considerable margin improvements in the past three years. In 2013, profit margins fell to 7.5% from 15%. Select Comfort’s margins have remained flat, but only because Select Comfort has transitioned to direct sales for much of its revenue. Thus, it doesn’t rely on distributors such as Mattress Firm, and it can control its own pricing and margins with its approach.

The fact that Tempur Sealy saw a 77.8% decline in net earnings to compliment 1.5% revenue growth during its last quarter is further evidence of the price cuts that are taking place in the mattress industry. Meanwhile, Select Comfort’s 4.7% net earnings growth compared to a 1.6% revenue decline during the same period is evidence that its business model is currently the most effective.

Final thoughts

My concern, moving forward, is if Mattress Firm is only seeing growth from new stores and acquisitions, and its suppliers have drastically cut prices in order to remain relevant, than how long will it be before mattress companies opt to consider a direct sales approach? Mattress Firm did say that volume increased in May, which is most likely why mattress companies are responding positively. However, I don’t see these trends as favorable for either Tempur Sealy or Mattress Firm, as margins continue to decline. Moreover, if I had to choose one company in a struggling space, there’s no doubt that it’d be Select Comfort. 

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Brian Nichols 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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