SNBR - Sleep Number: Pressure On Margin And No Growth Catalysts

Summary

• The company is trading below the fair level, but I do not see catalysts for the growth of shares.
• Consumer spending in the Furnishing segment continues to be under pressure.
• Decreasing economies of scale and chip shortages continue to weigh on operating margins.

Introduction

Shares of Sleep Number (SNBR) have risen 29% YTD. Since my publication 20 October 2022 , the company's stock is up 8% while the S&P 500 is up 10%. Despite the fact that I like the company and its business model, I decided to lower my forecasts for the company's future cash flows and changed my view to "Hold" due to high inflation, declining consumer spending and supply chain difficulties.

The survey of current trends

The growth of inflation and the decline in real incomes continue to have a negative impact on the dynamics of consumer spending of the population. Despite the fact that overall consumer spending is showing weak growth, spending in the Furnishings and durable household equipment segment continues to be in the negative zone throughout 2022. I believe that pressure on consumer spending will continue to be under pressure in 2023, which, in my opinion, could have a negative impact on the company's revenue growth dynamics. You can see the details of the dynamics of consumer spending in the charts below.

Projections

Due to macro and geopolitical uncertainties, the company's Q3 2022 financial results , as well as lower consumer spending in the Furnishings and durable household equipment segment, reduced economies of scale and chip shortages, I lowered my forecasts for the company's future cash flows. So, I lowered my forecast for revenue growth from 5% to 3% in 2022 due to pressure from consumer spending. In addition, I lowered my gross margin forecast from 58% to 57% in 2023 and increased my Sales and marketing (% of revenue) forecast from 43% to 43.5%. You can see the details of changing my input data in the chart below.

So the main inputs in my model are:

Revenue growth: I predict revenue growth to decline to 3% in 2023, then I conservatively assume 5% growth through 2026.

Gross margin: I believe that the gross margin will decrease to 57% in 2023, then I predict a stable level of 58% until 2026.

Sales and marketing: I assume an increase in sales and marketing (% of revenue) spending to 43.5% in 2023 due to reduced economies of scale, then I predict a gradual normalization to 42.5% by 2026.

You can see my updated cash flow forecast for the company in the chart below.

Yearly projections:

Valuation

I prefer to use the DCF approach to value a company. In my opinion, building a DCF model is the most preferred way to value a company because the company operates in a stable and predictable market. In addition, I can incorporate changes in revenue growth, profitability forecasts, and management comments into my model.

The main inputs in my model are:

WACC: 9.8%

Terminal growth rate: 3%

Multiples

In addition, I have updated the current and forecast P/E and P/S multiples, which are based on my Sales and Net income forecasts. You can see the results of my calculations in the chart below.

Risks

Macro: Declining consumer confidence, high inflation, lower real incomes may lead to lower consumer spending, which may have a negative impact on the company's revenue growth dynamics in the coming quarters.

Margin: Decreasing economies of scale, rising operating costs and the inability to pass on inflation to a weak consumer can lead to lower operating margins

Competition: Increased competition can lead to a decrease in market share or an increase in operating costs for marketing and wages

Drivers

Macro: A normalization of the macro and geopolitical environment could lead to a normalization of consumer behavior and a recovery in consumer spending, which could have a positive impact on business growth rates.

Margin: Efficient cost management and strict cost control, as well as lower inflation and higher prices for key products, could have a positive impact on operating margin going forward.

Conclusion

Despite the fact that the company has fundamental growth potential for the stock, I believe that now is not the best time to go long. In my personal opinion, high inflation, lower consumer confidence and real incomes could lead to pressure on consumer spending in the discretionary segment, which will have a negative impact on revenue growth. In addition, declining economies of scale and shortages of chips will continue to put pressure on the operating margin of the business. Also, the company announced a reduction in guidance for 2022. I may change my view of the stock later when I see signs of a normalization in consumer spending in the Furnishings and durable household equipment segment.

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