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About a year ago, I believed that the situation for bedding manufacturer Tempur Sealy International, Inc. (NYSE:TPX) looked comforting, at least at the time. This came as the business has been struggling for years, as the pandemic has been a blessing in disguise, triggering huge growth in sales and margins. Whilst forward multiples looked non-demanding, the reality was that it was uncertain what the realistic long term profit potential looked like.
Some Background
Early in 2020, Tempur Sealy announced its 2019 results, which was quite a solid year. The company grew sales some 15% to $3.1 billion for the year and while this growth pace looks alright, note that this compares to a $2.7 billion pro forma revenue base following the Sealy purchase all the way back to 2012. This really reveals that the 2010s were a lost decade for the business.
The company posted operating earnings of $347 million in 2019, on which it earned $3.50 per share on a GAAP basis, with adjusted earnings coming in fifty cents higher than that. Trading at $20 per share (or $80 if we factor in the four-for-one stock split), shares traded at 20 times adjusted earnings. With net debt posted at $1.5 billion, leverage ratios came in close to 3 times.
The company guided for solid earnings growth in 2020 ahead of the pandemic, with earnings set to come in above $5 per share, or $1.25 per share if we adjust for the stock split, as the valuation looked largely fair. Note that this came after difficult years in the 2010s as the company in many years did not live up to its promises.
Pandemic, A Blessing
The pandemic has been a blessing for the company, with consumers spending huge sums on discretionary and luxurious house items. First quarter sales rose 19% on the back of solid operational momentum ahead of the pandemic, as sales fell 8% in the second quarter. The company saw a huge recovery, with third quarter sales up 38% and fourth quarter sales up another 20%, as this resulted in full year sales being up 18% to $3.7 billion.
EBITDA improved to $780 per share as adjusted earnings came in at $1.91 per share, essentially $7.64 per share ahead of the stock split. Shares rose to the $30 mark ($120 on a pre-split basis), or about 15 times earnings, as leverage has fallen with net debt down to $1.3 billion, as leverage ratios fell much more. Moreover, the company guided for 2021 EBITDA of $900 million and earnings as high as $2.40 per share.
It was these results which made the shares rise to $42 in August of last year, in part because the company hiked the full year earnings guidance to $2.60 per share, as Tempur announced a $475 million deal for Dreams, a UK specialty bed retailer. Valued at around 1 times sales, while EBITDA margins came in the high-teens, this deal looked compelling with Tempur itself trading at more than 2 times sales, as the company even hiked the full year earnings guidance to $3.10-$3.25 per share.
Trading at 12-13 times earnings at $42, the valuation looked compelling, yet these were clearly not normal times, as net debt following the Dreams deal would increase to $1.9 billion. Given all of this, I was performing a balancing act with my long position which goes back to 2018. Momentum was very strong, as this prevented me from taking profits, yet I was not willing to add to my position given the potential normalization of earnings.
Disappointment
Fast forwarding a year, it can only be concluded that the performance has been disappointing as the normalization hurt shares more than I feared. After shares hit a high of $50 late last year, shares now trade at $27, even after a big recovery in recent weeks.
In October, Tempur posted a 20% increase in sales in the third quarter, as this marked the toughest comparable versus 2020 in which third quarter growth really stood out. The company narrowed and hiked the full year earnings guidance, seeing earnings at a midpoint of $3.25 per share. Net debt came in at just over $1.8 billion, as predicted at the time of the deal in the UK. With EBITDA trailing at $1.1 billion, leverage ratios were still very manageable at 1.7 times.
The company actually authorized and increased a buyback program before year-end as that aggressiveness and targeted 2-3 times elevated EBITDA number in terms of leverage should have made me a bit cautious. In February, Tempur posted its annual results as adjusted earnings of $3.19 per share actually came in a touch light, on the back of $912 million in operating earnings power on $4.9 billion in sales. Net debt inched up to $2.3 billion on the back of the accelerated buybacks, as the company guided for 15-20% sales growth in 2022, with earnings seen at a midpoint of $3.75 per share.
By April, Tempur posted first quarter sales growth at 19%, yet adjusted earnings per share rose just seven cents to $0.69 per share as the company kept increasing net debt to $2.5 billion by now, earmarking more funds to share buybacks, resulting in a 2.2 times leverage ratio. Following the softer quarter, the company guided for slower sales growth and amidst the impact of input inflation, it saw earnings at a midpoint of $3.30 per share.
In July the pain was really seen in the second quarter results, with revenues up just 4%, despite the acquisition of Dreams. Adjusted earnings fell twenty-one cents to $0.58 per share as the company guided for full year earnings at just $2.70 per share, down more than a dollar in a six-month period. In the meantime, aggressive buybacks have increased net debt to $2.8 billion. With adjusted EBITDA now falling to $1.05 billion, leverage ratios have rapidly increased to 2.7 times, as poor operational momentum will only increase leverage ratios in the coming quarters.
And Now?
Over the past twelve months, the company has spent $1.1 billion to buy back some 27 million shares, at an average just north of $40 per share. This has been a huge valuation destruction, and it has added more than a turn to the leverage ratio. This is all very painful, as softer operational performance might actually trigger financial concerns down the road as well.
After all, at $27 per share the 178 million shares outstanding now represent an equity value just south of $5 billion, as net debt is quite substantial by all means. Based on the current outlook, shares trade at just 10 times earnings, even if earnings have been downwards revised by a dollar. The issue is, of course, that the market believes that inflation and waning consumer demand might cast further pressure on these margins, as these earnings still represent solid (margins).
Further downside does not only have valuation implications, but mostly results in leverage concerns as well, as management has been far too aggressive and ill-timed its buybacks, as has been the case in the past.
Hence, I find myself in a tough spot. After holding a position in the mid-teens from 2018 onward, I still sit on decent gains, but recent performance has been lackluster.
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