SNBR - Sleep Number: A Promising Future Or Overhyped?

2023-07-19 12:42:12 ET

Summary

• Sleep Number Corporation demonstrated resilience amidst economic challenges, expanding its gross margin significantly in 2023, but faces potential overvaluation due to declining operating earnings growth rate and high P/E ratio.
• Despite uncertainties, the company's innovation-driven approach and strategic product launches present potential opportunities for growth, I recommend a cautious "hold" for the company's stock.
• The company's declining Operating Earnings Growth Rate and elevated P/E ratio suggest overvaluation, raising concerns about the stock's current price, despite strong Q1 results and gross margin expansion.

Thesis

In this article, I delve into the performance, valuation, and future outlook of Sleep Number Corporation ( SNBR ), a prominent player in the U.S. sleep solutions sector. Having demonstrated resilience amidst economic challenges and making significant strides in gross margin expansion in Q1 2023, the company faces questions of overvaluation due to a declining operating earnings growth rate and high P/E ratio. Despite uncertainties, Sleep Number's innovation-driven approach and strategic product launches present potential opportunities for growth, but with current overheated investor sentiment I settle on a cautious "hold" for the company's stock.

Company Overview

Sleep Number Corporation has a distinctive presence in the sleep solutions sector across the United States. Born as Select Comfort Corporation in 1987, the firm evolved into its current identity in November 2017. Headquartered in the heartland of Minneapolis, Minnesota, Sleep Number Corporation has cast a wide net by manufacturing and retailing their sleep products.

Their product portfolio is impressively diverse, ranging from beds and pillows to sheets and other bedding products, all marketed under the Sleep Number name, establishing a robust brand identity in the consumer's mind.

Sleep Number's Operating Profits Soar

Sleep Number's most recent (Q1 2023) performance stood as a testament to the company's resilience and innovative prowess in the face of larger economic challenges. With a relentless emphasis on innovation to sharpen its competitive edge, the firm has been able to tap into the promise of its SmartFed ecosystem, a digital platform that is integral to the well-being of its thriving 2.5 million-user community. A remarkable monthly engagement rate that exceeds 80% underscores the platform's potential as a future revenue generator.

The company, while acknowledging a modest dip in consumer sentiment, still managed to meet its anticipated targets for the first quarter. Their financial scorecard unveiled net sales that climbed to $527 million with a delivery of 90,000 smart beds, thanks to a steady supply of microchips after two long years of disruption. Remarkably, Sleep Number saw their Q1 gross margin inflate to 58.9%, a rise of 160 basis points from the year before, a result of strategic pricing shifts, a lessening tension in commodity pricing, and an agile, unified supply network. Operating profits catapulted from $4 million to $26 million, with earnings per share soaring to $0.51 from a mere $0.09 the previous year.

In a strategic move to supercharge demand as they roll into Q2 and beyond, Sleep Number is heralding the launch of their advanced i10 and M7 smart beds, coupled with a fresh collection of lifestyle furniture. The remaining smart beds are slated for a grand release early in Q3. These beds represent a quantum leap from the original Sleep Number 360, offering bespoke sleep solutions using data derived from exclusive research-grade sensors to understand biometric and sleep patterns.

Moreover, these advanced smart beds are enhanced with ceramic gel and foam layers to maintain temperature equilibrium and can sync with the new health and wellness platform that was unveiled last year. Their marketing engine is firing on all cylinders with an ad campaign featuring Hollywood's Gabrielle Union Wade and her husband, basketball superstar Dwyane Wade. The duo's widespread social media influence, combined with the advanced features of the beds, is projected to stoke more consumer interest.

Expectations

SNBR is covered by five Wall Street analysts with an average "Hold" rating on the company coupled with dim predictions that translate to a downside projection of -12.24% on its stock price.

Performance

Considering the dynamics of its share price, I'd like to draw our attention to two distinct periods: the near-term (Year-to-date) and mid-term (spanning a 9.5 year duration) before diving into a discourse on its valuation below.

Investors who have stepped into the field of this stock within the YTD window find themselves divided into two factions: Those who made their move earlier in the year, their outcomes swinging between breaking even and reaping substantial profits, and a latter group who began their accumulation spree towards the tail end of spring, with an emphasis on those who commenced their investment journey in May, and are now reveling in sizeable returns.

Author's note: At the time of my analysis, SNBR is climbing another 8% on the day.

Over the longer term, the data (see below) shows that SNBR's performance has been relatively steady over the past 9.5 years, beginning at $21.35 in 2014 and reaching $33.56 in 2023. That gives us an annualized rate of return (ROR) of 4.86%. That's not exactly jaw-dropping, especially when you look at it in contrast to the broader market, represented here by the S&P 500 Index . The S&P has given an annualized ROR of 9.93% and a compounded growth of 11.08%, outperforming SNBR considerably.

And here's the kicker - SNBR has no historic dividend data. That means all of its returns are reliant on stock price appreciation, whereas the S&P Index has provided investors with both capital gains and dividends, which have significantly contributed to its overall performance.

My take? I'm ambivalent. While SNBR's performance over the past 9.5 years is nothing to scoff at, it falls short when compared to the broader market. Its recent price surge provides some encouragement, but the absence of dividends is a potential red flag for certain investors. That is, if you're a growth-oriented investor with a higher risk tolerance, you might see promise in SNBR, particularly if you believe in its future growth potential. But if you're after reliable returns and dividend income, you might be better served elsewhere.

Valuation

One of the factors I am most concerned with is Sleep Number's declining Operating Earnings Growth Rate (see chart below), which has fallen by -12.25% indicating their operating profits have taken a drastic downward spiral - not an encouraging sign for any business. While this could be caused by various factors including higher operational expenses or reduced sales volume, ultimately it indicates they are struggling to remain profitable. This begs the question - is the recent surge in share price truly justified?

Now, let's consider the blended P/E ratio of 22.92x, which is significantly higher than both the 'P/E = G' rate and the company's historical normal P/E ratio of 15.13x. When a company's P/E ratio exceeds the industry norm, it usually indicates that investors expect higher earnings growth in the future. But in this case, considering Sleep Number's negative earnings growth rate, the elevated P/E ratio may suggest overvaluation. One might argue that the market is overly optimistic about Sleep Number's future earnings, which seems counterintuitive given the recent financial performance.

Outlook Remains Cautious

While sleep Number sailed into Q1 with financials hitting their projections on both the revenue and profit fronts, they're keeping a lid on their optimism for the rest of the year, however, tempering expectations even in the face of a potentially smoother ride in the next quarters.

Peering ahead, Sleep Number pins its 2023 full-year EPS forecast between $1.25 and $2. While they see the overall net sales landscape as flat or inching downwards, they're betting on an uptick in the latter half of the year. This optimism is fueled by softer comparisons and the advent of their new-gen smart beds that could boost net sales into moderate growth territory.

With an eye on fiscal health, the company aims to churn out over $100 million from operations and keep the free cash flows in the black this year. Also, they've decided against any share repurchase for 2023. As for Q2, they're bracing for a flat or minor drop in demand, which they expect to translate into a substantial dip in net sales. This prediction is especially stark against the backdrop of a 13% YoY net sales surge in the previous year's Q2.

Finally, according to management, Q2 (which we'll get more detailed optics on within their July 27's report ), usually marked by a seasonal ebb in demand, is likely to see Sleep Number in the red, a forecast based not only on the expected sales slump but also the anticipated YoY net sales drop.

Final Takeaway

Based on the presented information and data, I would objectively rate the Sleep Number Corporation's stock as a "hold". The company has shown remarkable resilience, delivering strong Q1 results amidst challenging economic conditions, and an impressive gross margin expansion. However, declining operating earnings growth rate and an elevated P/E ratio potentially suggest overvaluation, raising concerns about the stock's current price.

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