Friday, December 01, 2006

Why I bought more Select Comfort on disappointing news

Yesterday, Select Comfort reported that it was seeing a massive slow-down in sales and lowered its 2006 estimate to 80 to 87¢ a share. Since the previous guidance was 95 to 97¢, this was a huge disappointment. Last year, Select Comfort earned 76¢ a share (after adjusting for a 3/2 split), so the growth this year is between 5 and 14%. Worse Q4 earnings look to be 21 to 46% lower than 2005.

What happened?

According to the press release:

“This quarter’s sales have been disappointing, as we’ve noted a closer correlation in our business with housing industry trends. Our sales programs and promotional offers have been consistent with prior years, and we are protecting product margins,” said Bill McLaughlin, Select Comfort chairman and chief executive officer.
For a high-end furniture company, this is actually a decent excuse (though not encouraging). People moving into a new house tend to want new furniture to go with it and have access to cash from home equity lines of credit. Also, if the soft housing market foretells a recession (and it seems to be doing just that), customers might be holding off on large purchases for the moment.

But I think the specific problem for Select Comfort is the new ad campaign, which started this year. Two of the new commercials are available on the company website ("Five Senses" and "Revere"). If you aren't paying attention, you might be forgiven if you think these are drug ads (probably for sleep aids, but maybe anti-depressants or ED treatments). The bed just isn't a big part of the commercial. Sure, the message is clear if you pay attention, but you've got to figure that the people who aren't fixing themselves a snack are TiVoing through the commercials. In contrast, the previous commercials were funny and focused on the mattress itself.

The good news it that Select Comfort has already addressed the problem by hiring a new ad agency. Poking around their website, I think Select Comfort made a pretty good choice with the one reservation that McKinney also has Southern Comfort as a client. Overall, they seem to produce polished, memorable commercials often using humor. Their Sony commercials are especially informative, because like TVs, men and women need to agree on buying the same bed.

Based on the low earning range ($42,160,000) and low growth range (20% a year), a DCF shows Select Comfort to be worth over $40 a share. $18 a share implies a growth rate of about 8%. A more conservative estimate works out to a fair value of $21. I'm concerned about a recession in the next year that could further hurt earnings, but I think the problems are likely to be temporary. In the meantime, Select Comfort will be able to buyback shares at a reasonable price, improve its advertising and find operating efficiencies.

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