SNBR - Sleep Number: Take A Nap On This Stock For A While

Summary

• Why I think SNBR's chip supply chain issue may be worse than it seems.
• As the company stands today, if supply chain issues remain a significant headwind, it's going to be a tough year ahead.
• With its share price plunging from approximately $150 per share on March 1, 2020, it looks like it has larger issues than the supply chain.
• Once the macro-economic environment improves, along with consumer sentiment, the company could be positioned for a long-term, upward run.
• In the short term, I think it jumping by almost 50 percent is getting far ahead of itself and is likely to correct.

The last earnings report from Sleep Number Corporation ( SNBR ), while not surprising, was still a disaster, as the company continues to face a number of headwinds that, so far, it hasn't been able to mitigate.

While it focused on the weak macro-economic environment, higher costs of borrowing, consumer sentiment, and supply chain constraints, its focus on the supply chain as it relates to chips was considered to be the major headwind the company has been facing, and will continue to face for the foreseeable future.

Consequently, the company isn't too positive on its near-term performance, expecting headwinds to remain through at least the first half of 2023, and possibly longer, depending primarily on the chip issue.

In this article we'll go over some of its latest numbers, some of the headwinds, and why I think the supply chain related to chips may be a larger headwind than it has been.

Latest numbers

Revenue in the third quarter of 2022 was $540.6 million, compared to revenue of $640.4 million in the third quarter of 2021. Revenue in the first nine months of 2022 was $1.61 billion, compared to $1.7 billion in the first nine months of 2021.

Cost of sales was $237.5 million and operating expenses were $290.4 million, which when combined resulted in an operating income of $12.6 million. After taking away interest and income tax expenses, it had third quarter net income of $5.03 million, or $0.23 per share, compared to net income of $53.7 million, or $2.29 per share in the third quarter of 2021.

For the first nine months of 2022 the company generated net income of $42 million, or $1.87 per share, compared to $142.6 million in net income for the first nine months of 2021, or $5.84 per share. To get an idea of how weak the quarter was, net income for the first nine months of 2022 didn't come close to the net income produced in the third quarter of 2021.

Cash and cash equivalents at the end of the third quarter of 2022 was only $1.35 million. At the end of the third quarter the company had borrowed $406.3 million against its revolving credit facility, with over $410 million more in liquidity available to it under the revolver.

With less than $2 million in cash on its balance sheet, it's going to have to borrow its way out of headwinds it faces. With interest rates expected to continue to increase, that's going to add more to its costs over the next couple of quarters.

Supply chain chip constraints

When reading through the latest earnings report of SNBR, the first thing that immediately triggered a red flag to me was the comment that supply chain constraints in relationship to semiconductor chips remained a big problem for the company.

The reason it raised a red flag for me was all the company earnings I've been reading over the last several months pointed to an improvement in chip supply, even if it wasn't quite where the companies wanted them, i.e., there was still room for improvement.

So when going through the Q&A portion of the earnings call, I was glad to see that another analyst picked up on that, asking why the company was having so many issues associated with its supply chain when indications are the global supply chain is improving.

While CFO David Callen took the question as one associated with the overall supply chain, I believe the analyst was directly targeting the chip supply chain because of the narrative included in the earnings call.

The company directly attributed some of the weak numbers to a lack of chips, and guided for the fourth quarter to be even worse.

My point in bringing this up is, based upon virtually all the 200-plus company earnings reports I've read over the last three months, the supply chain for chips is improving; I can't recall one company that said there wasn't significant improvement.

The obvious question then is, why isn't it showing signs of improvement with SNBR?

While there may be more than one answer, I think the reason is chip companies are prioritizing chip deliveries to traditional tech companies that require far more chips than SNBR does. In other words, they're going to deliver chips to their largest customers first.

A possible secondary factor could be the company is still learning how to work with the supply chain as it increases the number of smart beds as a percentage of its overall volume and revenue.

If it's the latter, then SNBR could be facing more issues in the near future, especially after guiding for a lot more chips to be delivered in the latter part of the fourth quarter of calendar 2022.

Whether the reason is external or internal, or possibly both, chip supply remains a big issue for the company, and if positive guidance concerning delivery improvement of chips fails to come about again, the share price of the company will take another big hit.

Consumer sentiment

With the share price of Sleep Number collapsing from $150 per share in early March 2021, to as low as $23.60 per share on November 4, 2022, it's apparent that the blame for its performance can't be fully laid on supply chain constraints; there are other headwinds it faces that are just as formidable, if not more formidable.

Most of that is related to the macro-economic environment related to inflation, high interest rates, and uncertainty in the labor market, which is causing consumers to pull back on spending on products or services not considered to be needs.

Outside of live events and travel, consumers have tightened spending, and that is having a direct impact on the performance of SNBR.

The combination of inflation and interest rates have an impact on buying decisions because of the added cost of paying down debt associated with more expensive money. That, as well as concerns over the uncertainty of the labor market as a consequence of the rising number of layoffs, terminations, and lower number of new hires, contribute to a weaker consumer spending environment, which isn't going to go away in the near future.

So, while SNBR does have a chip supply chain issue, even if much of that was mitigated, it would still face weak consumer sentiment that is likely to get worse as the Federal Reserve continues to raise interest rates and more people are laid off.

This is why I believe the huge surge in the share price of the company is too fast, too soon, and until there is confirmation of the delivery of chips that will allow the company to boost deliveries of its smart beds, I would hold off on taking a position in the company, as it's primed for a potentially big correction.

Conclusion

Over the long term I think SNBR could be a solid holding, but with very little cash, the need to borrow more to fund operations, a weak supply chain for its chips, and an economy that is probably going to get worse before it gets better, the short-term outlook for SNBR is very weak.

I think the recent increase in its share price is not much more than a bounce from its 52-week low, and secondarily, possibly an anticipation of improved sales if chip deliveries meet expectations and result in better numbers.

According to management that's not going to happen in the fourth quarter, so the next earnings report, unless there is an unforeseen surprise to the upside, is going to result in downward pressure on the stock.

And if the company experiences another shortfall in its chip supply, along with further uncertainty of chip deliveries after that, it's probably going to test its 52-week low.

I see taking a position in SNBR as far riskier now that it has soared almost 50 percent from its 52-week low in December 2022, based on nothing more than the possibility it may get more chip deliveries that could boost its performance in the first quarter of 2023.

That may happen, but as mentioned, there are more headwinds the company is facing than chips alone, and those headwinds are probably going to get worse over the first half of 2023. Proceed with caution.

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