This Mattress Stock Lets You Sleep at Night

Analysts and research firms ambushed the mattress business earlier this year, pushing the idea that demand was soft (no pun intended). But as reality set in and the market realized people were indeed continuing to sleep, the space ended up being very profitable for investors. Among the best performers this year was Select Comfort  (Nasdaq: SCSS  ) . The stock posted major gains of nearly 50% so far this year, while weathering a huge drop in the beginning of the summer due to the aforementioned forecasts. Things have stabilized since then for the company and its competitors, but the latest earnings report scared analysts with weaker-than-expected guidance. What should investors take away from Select Comfort's third-quarter earnings?

The raw
Things look great on the surface for Select Comfort. The inventors of the Sleep Number system posted record third-quarter sales of $247 million -- a 24% increase over the prior year. With its many Sleep Number branded stores, found in a mall near you, comparable sales growth was an impressive 21% year over year. Operating margins were up to a healthy (and also a record) 16.3%. This helped drive earnings-per-share growth to more than 48% from last year.

With $193 million in cash on the books and no debt to speak of, this company appears to be in great shape. So why didn't the stock budge?

The company actually increased its guidance for full year 2012. 2012 EPS is now expected to be in the range of $1.45 to $1.47. While that sounds great, it turns out analysts wanted a little more. Some are saying this signals, again, weak demand in the mattress market. The economic climate is without doubt shaky, and it's very hard to predict consumer activity going forward, but I believe Select Comfort has established itself as a true market leader that rewards shareholders with conservative management focused on long-term growth.

Nitty and gritty
In the company's conference call, there were some very interesting numbers. For one, average mattress sales per unit during the quarter were nearly $2,700. That is a record for the company, and would certainly be a record for me if I were buying a mattress.

As far as sales per square foot, a metric dominated by tech behemoth Apple, Select Comfort comes in as the fifth highest of any retail operation. lululemon athletica, Tiffany, and Coach finish out the top five. Clearly, the Sleep Number personalized sales approach is paying off in spades for the company, which has been building the brand for some years and just now flexing its profitability.

According to management, the local market development initiatives have exceeded expectations, as evidenced by the strong store performances. This is leading the company to more aggressively open stores, something they have very cautiously approached in the past. The company is aiming to open 14 to 18 net stores in the fourth quarter alone.

With the exception of missed guidance, it appears to me this company is doing fantastically.

Where's the play?
Select Comfort is without doubt, in my mind, killing it. The yearlong double in stock price would keep me from buying shares, as I am dedicated to buying on the cheap. But its competitor Tempur-Pedic (NYSE: TPX  ) is interesting as well and a bit less pricey. The company hasn't reported earnings yet, but its forward earnings ratio of 10.81 is far below that of Select Comfort's 17.83.

There are a couple of things to consider, though, in buying Tempur-Pedic. For one, the company recently made a bid for mattress giant Sealy (NYSE: ZZ  ) at $2.20 per share. Sealy's board is backing the bid, along with majority shareholder KKR. The deal looks to benefit Tempur-Pedic, as some are crying out that Sealy didn't shop itself around enough and now is getting a weak price for its share. That would be great for Tempur-Pedic.

The company is also opening up its own branded stores. This, to me, is a very interesting development, as it has been one of the main factors, if not the main, in Select Comfort's recent successes. Tempur-Pedic stores would raise brand awareness, and give the company better pricing ability and margins without the middleman.

All in all
Though I would be tempted to buy the cheaper Tempur-Pedic, Select Comfort is in no way a shabby stock. Management was very enthusiastic about the future of the company, and recent numbers only support a bullish thesis.

Keep an eye out for any pullback in the stock due to the guidance issue, and you could grab yourself a quick bargain on this strong performer.

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Fool contributor Michael B. Lewis has no positions in the stocks mentioned above. The Motley Fool owns shares of Tempur-Pedic International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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