A Member of Pat McKeough’s Inner Circle recently sent him a question about a Canadian retail stock that has had its ups and downs.
Several years of strong growth by Sleep Country Canada were followed by sluggish earnings and a sliding share price late in 2017. The company has strong competition from online retailers in its field, Pat notes, and was hindered by heavy advertising expenses. The bankruptcy of Sears Canada and Sleep Country’s own online product may help revive its earnings, he adds, but the company must keep investing heavily to maintain its nationwide chain of stores.
Q: Hi, Pat. Sleep Country Canada stock took a price hit late last year. May I have your opinion on this company? Regards.
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A: SLEEP COUNTRY CANADA HOLDINGS INC. (symbol ZZZ on Toronto; www.sleepcountry.ca) is the dominant specialty mattress retailer in Canada. The company operates 247 stores across the country, along with 16 distribution centres. Its product offerings include mattress sets as well as sleep-related accessories such as bed frames, pillows, mattress pads, sheets, duvets, headboards, footboards and platforms.
Stephen Gunn, Christine Magee and Gord Lownds founded Sleep Country in Vancouver in 1994. In 2003, the company, then an income trust, began trading on the Toronto exchange at $10 a unit.
Toronto-based firms Birch Hill Equity Partners Management Inc. and Westerkirk Capital Inc. took Sleep Country private after acquiring it in 2008.
In 2015, they re-listed the company on the Toronto exchange through an initial public offering or IPO. The public bought a total of 17.65 million shares at $17 each. The stock has doubled since that time.
Sleep Country’s revenue rose 14.8% from $456.2 million in 2015, its first year of trading, to $523.8 million in 2016. Earnings, excluding one-time items, climbed 30.0%, to $39.3 million, or $1.05 a share, in 2015, to $51.1 million, or $1.36, in 2016.
The gains were the result of opening new stores, and the company’s successful and high-profile marketing. Steady demand for Sleep Country’s expanding range of products also contributed.
The stock took a big drop at the start of November 2017 following the company’s weaker-than-expected results for its 2017 third quarter. Traditionally, that period is Sleep Country’s strongest quarter.
In the three months ended September 30, 2017, excluding one-time items, the company earned $23.5 million, or $0.63 a share. That’s up 7.6% from $21.9 million, or $0.58, a year earlier. However, it’s below the consensus forecast of $0.66 a share.
In the quarter, revenue rose 10.1%, to $177.1 million from $160.8 million.
Growth stocks: Demise of Sears Canada should benefit Sleep Country
The company’s sluggish earnings growth was in part related to the company’s investments in its e-commerce websites and distribution network. Still, putting those growth investments aside, Sleep Country spent a lot more on its advertising, which simply failed to generate the higher sales (and profits) it expected.
The company’s balance sheet is very sound, with cash of $28.8 million, or $0.76 a share, and almost no debt.
As Canada’s leading mattress seller, Sleep Country could be one of the biggest beneficiaries of the demise of Sears Canada. Before its bankruptcy, Sears was Canada’s second-largest mattress seller.
However, Sleep Country still faces fierce competition from the rising popularity of online retailers. Those low-cost sellers include Casper, Leesa and Endy and offer a very limited (and cost-effective) range of memory-foam mattresses at fixed prices. As part of their service, they compress and ship their mattresses in suitcase-sized boxes.
Sleep Country has launched its own website to compete in the online mattress market. It has branded those less-expensive mattresses “Bloom” beds. Even so, any sales success here is likely to eat into sales of the company’s full-priced mattresses.
Sleep Country also needs to keep investing significant amounts to upgrade and refresh its chain of stores. In addition, it must continue to attract customers to those bricks-and-mortar locations.
The stock trades at 19.1 times the company’s forecast 2018 earnings per share of $1.77. The shares yield 2.0%.
Inner Circle recommendation: We don’t recommend shares of Sleep Country.
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