By the looks of the trading action this morning, bed maker Tempur-Pedic (NYSE:TPX) is giving investors nightmares after saying sales are slowing in Europe and profits this year won't be as robust as previously projected. With the earnings warning coming as it tries to swallow rival Sealy (NYSE:ZZ) in a $229 million acquisition, investors should be worried they'll be losing more than a good night's sleep.
Tempur-Pedic was rising off its midyear lows as housing data looked encouraging heading into the fall, at least from some angles, but with the possibility of more people buying new homes (presumably leading to buying new mattresses), the mattress maker even opened its first retail store. Following the lead of Select Comfort (NASDAQ:SCSS), Tempur-Pedic will also be selling mattresses in a bricks-and mortar environment.
No doubt they've seen Select Comfort's model as holding hope for boosting profits. Select Comfort enjoyed a 52% increase in profits in the third quarter as comps went higher, generating a 24% jump in sales.
Restless leg syndrome
Certainly I was more enamored of its low-overhead-cost business model than having Tempur-Pedic take on greater expenses during a period of economic uncertainty and tighter competition. That was one of the rationales for buying Sealy in the first place: Since its own beds were pricier than the competition's, the purchase gave it an entry-level offering for consumers. But it will also increase its debt load, and with Sealy running losses in eight of the last nine quarters, that's like putting a pea under its mattress that will keep it tossing and turning all night.
Sure, management says they'll generate $40 million in synergies from merging the two businesses, but those things tend not to work out as expected.
Instead, Tempur-Pedic is trying to get the consumer to still be comfortable with bedding at around $2,500, a difficult sell particularly because they're dropped the price on a number of bed lines and haven't been able to upsell many customers Their $1,400 Simplicity line remains a material part of TP's business, but it hasn't performed nearly as well as expected.
With the financial tumult in Europe, the bed maker saw sales stall in the quarter. Unlike in North America, where competition is heating up, on the Continent it remains a matter of macroeconomics. Its rivals here are eating away at its position, with sales falling 15%, though it maintains that the trends improved somewhat, so that fourth-quarter sales will only be off 10%. For the full year, Tempur-Pedic said it would earn $2.55 a share, below the $2.80 a share the company had guided to in July and worse than the consensus estimates of Wall Street.
Tempur-Pedic has lost more than 70% of its value from its 52-week highs and is down more than 50% over the past year. The battle for bedding has become intense, but the mattress maker believes the specialty niche will continue to be a growth spot.
While Europe is worrisome, more than three-quarters of Tempur-Pedic's revenues are from domestic sales, and as sour as I am on housing, I believe the company can still benefit from any improvement in the industry. Moreover, I do think that the Sealy acquisition gives it the necessary diversity to make gains against its rivals. Wal-Mart (NYSE:WMT) and Costco (NASDAQ:COST) are an ever-present threat, and being able to offer consumers a lower-cost model along with its more typical higher-end bedding options gives it the breadth of product to wring out those synergies it believes the deal carries.
If the trends that management alluded to continue through the fourth quarter and into 2013, we should see those investors who use the current drop in value as a chance to buy in resting easy. The risk, of course, is that it turns into a union of two damaged companies (e.g., Sears and Kmart). I don't think Tempur-Pedic is in the same class, but it may yet feel the weight of having to carry Sealy across the threshold.
Rich Duprey has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale and Tempur-Pedic International. Motley Fool newsletter services recommend Costco Wholesale and Wal-Mart Stores. 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.