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I Love This Company's Products -- But I Would Short The Stock

Tuesday, November 19, 2013 10:00 AM

Every home has at least one. From the White House to a shotgun shack in Appalachia, this product is notable for its widespread use across every demographic.

Virtually all of us spend nearly a third of our lives using this product, which commands a wide range of prices -- from less than $100 for basic versions to well over $10,000 for custom-built ones. In addition, this product is so commonplace you might not give it a second thought after the purchasing decision. U.S. manufacturers produce about 35 million units a year, and the industry's revenues neared $6 billion in 2009.

If you haven't guessed it yet, I am referring to the lowly mattress. I recently had a great experience with a particular brand over the last several years, but right now I would avoid or even short the stock.

When my wife and I were newlyweds, one of the most important purchases for our new household was a mattress. I'm a restless sleeper, and my wife sleeps so silently and still that sometimes I have to check to be sure she's still breathing. My rolling about at night disturbs my wife when we sleep on spring-based mattress, so much so that we often sleep in separate beds when in hotels.

The memory of a TV commercial from the late 1990s -- in which a person is jumping on a bed but not spilling a wine glass sitting on the same bed -- sent me looking for this mattress brand. Considering the hyperbole used in commercials, I wasn't expecting the mattress to live up to the TV ad -- but I was willing to give it a try.

Talk about being pleasantly surprised! Not only was this mattress exceedingly comfortable, I could roll around with abandon and my wife would barely feel the movement on the other side of the bed. It truly is the rare product that performs exactly as advertised. It's been three years since our purchase, and this mattress has held up as the most comfortable and practical mattress either of us have ever used.

Based on this positive experience, I took a close look at the company as a potential investment. The mattress is called Tempurpedic, and the manufacturer is Tempur Sealy International (NYSE: TPX).

The world's largest bedding manufacturer, Tempur Sealy was formed by the merger of Tempur-Pedic International and Sealy Corp. this year . The Lexington, Ky.-based company's brands include Sealy, Tempur-Pedic, Posturepedic and Stearns & Foster. The Tempur-Pedic mattress was the result of 10 years of research, originally for NASA, culminating in the founding of the U.S. Tempur business in 1992. The Sealy part of the company was founded in 1881.

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The memory of a TV commercial from the late 1990s -- in which a person is jumping on a bed but not spilling a wine glass sitting on the same bed -- prompted a search for this mattress brand.

Boasting a market cap of $2.8 billion, Tempur Sealy had more than $1.4 billion in revenue last year and has nearly $127 million of total cash, but its third-quarter results are what have me excited about its investment potential. Earnings per share (EPS) came in at $0.65 for the quarter, compared with a loss of $0.03 during the same period last year.

The radical improvement is due to acquisition transaction costs and interest fees related to refinancing. The loss in 2012 was due to tax charges related to the merger. Income has also ramped up significantly in the third quarter. However, it's important to note that gross margin slipped to just under 41% from a little over 49% in the same time last year. This is due to the fact that the Sealy acquisition has lower margins than Tempur-Pedic.

In addition to the third quarter improvement, Tempur Sealy confirmed its full year EPS forecast of $2.25 to $2.40 on sales of about $2.4 billion. This compares favorably to the consensus analyst EPS estimate of $2.10.

Technically, shares have gapped up on the overall positive third quarter, then dropped to support at $44 before pushing back to the highs near $47. This has created a very precarious double-top pattern on the daily price chart. I really like this company and wanted to provide a buy recommendation, but due to the technical picture, I suggest shorting shares at this level.

Despite the fundamental improvement, Tempur Sealy's management has expressed concerned about its European segment. Between the stock being up more than 50% this year and the bearish chart pattern, I would short TPX right now -- or avoid it entirely.

Risks to Consider: Chart patterns are not always accurate when it comes to forecasting future price. Stocks can remain overextended for much longer periods of time than may seem possible on a chart. Shorting a stock has its own risk factors, including unlimited theoretical losses. The use of stop-loss orders is critical when shorting shares.

Action to Take --> Shorting TPX anywhere between $46 and $47.50 makes solid sense. I think all the good news is already baked into the stock and I expect it to decline in value soon. The six-month target price is $38, and initial short stops should be placed at $48.50.

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David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.