The following is a reprint of my January 28, 2008 RealMoney column.
When I wrote about Tempur Pedic (TPX) in December, I said “some concern is still warranted given the declining housing market and other signs that the economy may be slowing.” Although the shares appeared attractive based on the then-expected 23% earnings growth in 2008 and 17% five-year consensus growth forecast, that attractiveness depended heavily on the forecasts.
On Friday, those estimates were taken down a few notches after the company reported earnings. The company’s new guidance was “net sales for 2008 to range from $1.195 billion to $1.250 billion, an increase of 8% to 13% over 2007…. EPS for 2008 to range from $2.03 to $2.20 per diluted share…. an increase of 17% to 26%.” The consensus estimate is now $2.06, well below the mid-point of management’s guidance.
That doesn’t mean I think the estimates are now too low, however. None of the issues the company was facing then have gone away.
To me, the most telling sign in the press release was management’s excitement over new product launches. “Next week, we will introduce a new mattress model in the U.S…. This model… will have a suggested retail price point of $3,999 for a queen size mattress.” Four thousand dollar mattresses aren’t likely to be high on cash strapped consumer’s shopping lists.
So even though the current consensus estimates are at the low end of management’s new guidance, I wouldn’t be at all surprised to see additional cuts to future estimates. However, the valuation is low enough that I wouldn’t want to risk being short the name, either.
The shares are trading at barely 8x the current-year consensus EPS estimate. Free cash flow to the firm (operating cash flow, plus after-tax interest, less capital expenditures) over the last 12 months was $130 million, and that number was lower than would otherwise be sustainable because the company had to make up for an inventory shortfall due to high demand and production problems early last year.
Even at the potentially conservative cash flow number, the current free cash flow yield of 6.6% is nearly 500 basis points higher than the 5-year Treasury. And even with the now-lowered numbers Wall Street is expecting 13% earnings growth on average over the next five years. Hardly what I would consider an ideal short.
There is one way to play Tempur Pedic that I think may prove profitable, though. Selling put options would allow you to keep the insurance premium if the shares don’t drop further, and would reduce the effective purchase price if they do have further to fall.
For example, the February $17.50 puts closed at $0.65 on Friday. By writing the puts, an investor could keep that $0.65 (a 3.7% one-month return on the money at risk) as long as the shares didn’t fall more than 7.75% from Friday’s close in the next month. The trade would still be profitable up to an 11.2% decline in the stock from the Friday close.
Alternatively, the longer-term options may also work. The midpoint of the spread for January 2009 $17.50 puts was $3.15. At this premium, the one-year return is potentially 18% on the money risked provided the shares remain above the strike price. As long as the shares stay above $14.35 (nearly a 25% drop from Friday’s close) the trade would be profitable.
So rather than buy the shares or short the shares today, I’d rather wait… or get paid to wait.
