CA - Sleep Country: A Roll-Up (Mattress) Strategy

2023-04-24 00:31:05 ET

Summary

• Sleep Country has been acquiring direct-to-consumer online mattress brands including Endy and Casper as it expands its sales channels from brick and mortar.
• Investments in e-commerce platforms and better leverage of consumer data are leading to market share growth and margin improvements.
• The company is committed to growing its dividend annually by 10% or more.
• In addition to steady dividend growth, the company has been active in repurchasing shares with 6.7% of float cancelled in 2022 and an NCIB worth 10% of float approved for 2023.

Author's Note: All figures in Canadian currency unless otherwise noted.

Investment Thesis

If you can't beat them, buy them. Sleep Country Canada Holdings Inc. (SCCAF) (ZZZ:CA) is doubling down on a strategy of purchasing mattress-in-a-box brands with online delivery platforms. The company has transformed itself from a purely brick and mortar retailer to a multi-channel sales platform that includes direct-to-consumer mattress-in-a-box brands such as Endy and its recent purchase of Casper.

Sleep Country benefits from strong brand recognition in Canada and has been successful in growing market share since the pandemic. The company has low debt, strong free cash flow and a commitment to grow its dividend by 10% annually. Sleep Country has been returning capital to shareholders through a substantial share repurchase effort and a dividend currently yielding 3.6%.

Company Profile

Three years ago, Sleep Country began a transformation from a traditional brick and mortar retailer to a leading omnichannel and ecommerce player. Through investments in digital and distribution infrastructure, the company has modernized and adapted to e-commerce trends. With approximately one quarter of mattress market share in Canada, Sleep Country sells under three mattress retail brands: Sleep Country Canada , Dormez-vous in Quebec and online as Endy , one of Canada's best recognized mattress-in-a-box label.

In addition to its 289 corporately owned stores and 20 warehouses across Canada, Sleep Country has 17 "store in-store" locations in Walmart ( WMT ) Supercentres under its Sleep Country and Dormez-vous Express brands. In addition to mattresses, nearly one quarter of revenue is from accessories including pillows, black-out curtains and bedding.

Sleep Country employs a capital-light model predicated on leasing stores, warehouses and trucks. This capital model only requires maintenance capex of approximately 1% of revenue annually to maintain assets. This allows the company to pursue organic growth and acquisitions without significant debt. In addition to ongoing investment in digital sales channels, Sleep Country is investing in six new stores. For a capital outlay of $460K, a new store generates average sales of $1.79M during the first year of operations. This model allows for a quick payback period of approximately ten months. To keep its physical retail spaces Sleep Country is currently undergoing a store renovation program targeting 20-30 renovations to refresh its brick and mortar spaces.

Sleep Country went public in 2015 and trades on the Toronto Stock Exchange with daily average volume of approximately 90,000 shares. With 2022 revenues of $928M, the retailer has a market capitalization of $820M.

Recent Results

Sleep Country grew revenue by $8.5M or 0.9% to $928.7M in 2022 from $920.2M in 2021. Over the same period, EBITDA grew by $11M from $199.5M in 2021 to $210.5M in 2022. Operating EBITDA margin increased 60 bps from 22.9% in 2021 to 23.5% in 2022, while the company's gross profit margin increased by 2.20% to 36.7% from 2021 to 2022. Improvements in operating margin reflect a diversification of sales channels away from traditional brick and mortar and a 9.2% improvement in the accessories category; where margins tend to be 10% higher than on mattresses.

For FY 2022, adjusted net income increased 4.6% from $98.3M in 2021 to $102.9M in 2022 and diluted adjusted EPS grew by $0.17 or 6.4% to $2.81 in 2022. EPS growth has been accelerated by the repurchase of shares for cancellation.

Growing E-Commerce Presence

In November 2018, Sleep Country made its first significant foray into the -commerce mattress landscape with its $88.7M acquisition of Endy, one of Canada's leading bed-in-a-box brands. Similar to how it would structure future deals, Sleep Country paid $63.7M in cash and up to $25M in 2021 based on Endy's achievement of profitability targets.

In December 2022, Sleep Country announced plans to acquire Silk & Snow Inc., a Toronto-based online retailer of mattresses and sleep accessories. Sleep Country will pay $24.M in cash at closing and up to an additional $19.45M in cash in early 2026 based on Silk and Snow achieving growth and profitability targets. Silk & Snow will maintain its brand identity and operate as an independent entity within Sleep Country. Sales to U.S. customers represent a quarter of current Silk and Snow sales, which allows Sleep Country to further revenue growth and diversification opportunities.

In the company's most recent deal, Sleep Country has agreed to purchase Casper Sleep Inc.'s Canadian assets. Sleep Country will pay US$20.6M in cash and will receive US$4.5M in marketing support from Casper over the next four years. Sleep Country will also receive warrants which would convert into an approximately 1% stake in Casper. As a supplementary move to this transaction, Sleep Country has invested US$20M in convertible notes which gives the company the option to convert notes into an additional 5% of Casper shares when exercised.

The percentage of revenues from e-commerce platforms decreased 3.9% from 23.5% in 2021 to 19.6% in 2022 as consumers returned to brick and mortar retail in the post-pandemic landscape. Sleep Country's recent investments in e-commerce and data should drive the portion of sales from e-commerce and subsequently support margin growth.

Omnichannel Retail

Since August 2021, Sleep Country has partnered with Walmart Canada to open "Sleep Country Express" store-in-stores within Walmart Centres. In October 2023, Sleep Country announced its plans to open an additional seven embedded stores within Walmart, bringing the total to 17. On its most recent earnings call, Sleep Country Management confirmed the company's plans to expand this model to 80-100 Walmart locations over the next few years.

A new store concept expansion in Q2 2023 could include a pilot with some of the company's online brands being featured with their own brick and mortar retail locations. In addition to potentially featuring these brands in a physical retail space, Sleep Country has prioritized investment in leveraging the company's customer data. According to President & CEO Stewart Schaefer:

With a focus on investment in harnessing our data, we look forward to continuing to build on our relationships with our customers by thoughtfully procuring customized offerings that suits their every life stage, while maximizing our lifetime value of our loyal and growing customer base.

Dividend Growth & Returning Capital

In February 2022, Sleep Country declared a quarterly dividend of $0.215 per share, a 7.7% increase from its prior dividend of $0.195. Since 2015, Sleep Country has delivered average annual dividend growth per year of 7.5%. With a dividend payout ratio of under 30%, the company has room to follow through on its commitment of increase the dividend 10% or more annually. The current yield of 3.65% is well above the 4-year average dividend yield of 3.05%.

In 2022 Sleep Country, completed total share repurchases of $58M or 6.7% of shares outstanding. As of March 2023, the company had been approved for a new NCIB allowing for the repurchase of 2,675,550 shares for approximately 10% of its public float. With a strong balance sheet, the company has significant optionality to deploy capital to share repurchases on share price weakness or on dividend growth and additional acquisitions.

Risk Analysis

Sleep Country has a healthy balance sheet with leverage of 1.4X. As of Q4 2022, the Company's cash balance was $78.3M with an additional $160M of liquidity available through a credit facility and another $100M accordion. This compares to long term debt of approximately $99M and total debt and lease liabilities of $374M.

As part of its brand identity as a retailer of premium brands, Sleep Country relies on a number of key mattress manufacturers and suppliers including Tempur Sealy ( TPX ), Serta and Simmons. Equally, the company has market place presence with Walmart, Loblaw ( L:CA ) and Best Buy ( BBY ). Should any of these suppliers or distribution partners end their relationship with Sleep Country, it could erode the company's multifaceted sales channel.

So far, Sleep Country has been able to buy its upstart competition and compete in the e-commerce space. Should additional online retailers continue to take market share, Sleep Country may struggle to compete on price. While the global mattress market is expected to grow at a CAGR of 5.36% from 2022-2029, this growth is in part fueled by travel. If there were to be another major disruption to global travel such as a pandemic, it would dampen the demand for mattresses in the tourism sector.

While the demand fundamentals are strong for the mattress market overall, there are some noteworthy challenges. The average mattress lifespan is seven to ten years, however newer materials may extend the product lifespan, reducing the frequency of purchase. The other challenge with this product lifespan is retaining customers for subsequent repurchases over such a long time horizon. The increase in focus on wellness, sleep health and the related growth in sleep accessories helps to keep customers connected and promote brand loyalty to the retailer.

Investor Takeaways

Sleep Country's transformation from a brick and mortar retailer into a true multi-channel retail platform has been impressive. The company's strong balance sheet has enabled it to pursue a number of targeted acquisitions that grow its e-commerce presence and support margin expansion. Growth in the sleep accessories product line and the opportunity to expand beyond the domestic Canadian market through its e-commerce labels are catalysts for growth. With a commitment to grow the dividend 10% annually and a robust share buyback program, Sleep Country plans to return significant capital to shareholders.

For further details see: