Mattress Firm (MFRM) is a mattress retail roll-up story that has doubled in value since coming public in 2011. MFRM is a posterchild for earnings quality analysis. A deep dive into the company’s accounts shows a reporting approach that is at best promotional, and at worst misleading.
In reporting its quarterly operating results,
management makes liberal use of a wide variety of non-GAAP financial metrics,
including (but not limited to) Adjusted EPS, Adjusted Cash EPS, EBITDA, and
Adjusted EBITDA. The business model is fairly simple, so it’s not quite clear
why so many varied metrics would be necessary in order to properly understand
the business. Part of the rationale appears to be that the ‘Adjusted’ metrics
leave off acquisition-related costs (as well as many other items). The only
problem is that when you’ve done this many acquisitions (see below), then that
is simply a part of your (possibly your entire?) business model. It’s hard to
make the case that those costs should be excluded in order to properly reflect
the business.
source: company presentation November 2015
Economies of Scale?
Presumably, MFRM’s roll-up strategy is predicated
on the ability to extract value from the newly acquired stores over time. Possible
sources of value creation could include cost reductions, revenue synergies, or opportunities
for attractive CapEx investment. But a comprehensive review of MFRM’s operations
calls into question whether the company’s acquisition roll-up strategy is
actually creating value over time. A careful analysis shows that most of MFRM’s
operational metrics have actually deteriorated since the 2011-2012 time frame.
Whether via management discretion or purely incidental, MFRM’s business metrics
built momentum and peaked shortly after the IPO in late 2011.
The first interesting metric is comparable store
sales. This concept is an important one for all retailers. In some form or
another, the purpose is to measure the performance for stores versus the year
ago period for all stores that were open during both periods. It is designed to
portray the underlying business performance exclusive of new stores (whether
acquired or built). MFRM has a convoluted definition for its comparable store
sales measure (see p. 35). Within its
calculation of comp store sales, MFRM includes sales from relocated stores, as
well as online sales. Management regularly reports and provides guidance on
this basis. Yet the 10K also includes a measure called “average net sales per
store unit”. Despite not being the metric that management regularly touts, it
is actually closer to the expected definition of same store sales, capturing “sales
for stores open at both the beginning and the end of the period, excluding
e-commerce and multi-channel sales”. The chart below shows the trending of both
of these metrics over time.
Notice in the final column that MFRM’s reported
comparable store sales metric consistently exceeds the sales per store unit
metric. Mechanically, this means that relocated stores and e-commerce sales
serve to benefit the reported comps metric, although the company does not
disclose any breakout of those components. Also note that the company has not
reported a negative comp store sales year since the IPO in 2011. Yet the more
conventionally calculated metric was negative in 2013.
Next we will go through the trends in various
metrics for the business, using both the company’s preferred metrics as well as
other conventional measures of profitability.
The first thing to note in the chart is the growth
in store count. We know that MFRM is a retail roll-up story, but the sheer
growth in stores is amazing. The company’s store footprint has grown over 5x
since 2008. And the recently announced acquisition of Sleepy’s will add 1,066 stores. Despite this
massive growth in scale, though, we are seeing deterioration in per-store
economics and stagnation in company margins. The bottom of the chart shows the
trend in management’s preferred metric of Adjusted EBITDA. 2014 marked the
lowest Adjusted EBITDA margin since 2008, while Adjusted EBTIDA per average
store had fallen back toward 2010 levels. This trend flies against the notion
that MFRM’s massive scale expansion is leading to economic benefits.
If we then switch over from the company’s preferred
metrics to more conventional measures, note that gross margin has basically
stagnated for four years, after reaching 39%+ levels in 2011. Similarly, SG&A
expense leverage has actually gone the wrong direction. The exponential rise in
store count has resulted in SG&A % of sales approaching 33%, up from 29%
earlier in MFRM’s history. Again, this is a discouraging result for believers
in the company’s scaling roll-up strategy. On a per-store basis, MFRM earned
only $57k per store in FY 2014, net of COGS and SG&A – a level not seen
since 2009.
The next chart compares these profitability
measures to MFRM’s cash flow trends.
Similar to the SG&A margin trends just
mentioned, the chart shows that MFRM’s operating cash flow per average store in
FY 2014 fell 30% to levels not seen since before 2010 – only $63k per store.
Again, whether we use true operating cash flow or the company’s preferred Adjusted
EBITDA metric, the trend is basically the same. As a final assessment of MFRM’s
operating efficiency gains (or lack thereof) due to scale, the next chart shows
the trend in cash conversion cycle.
In addition to margin stagnation and deterioration
in per-store economics, MFRM’s cash conversion cycle trend is an indictment of
the company’s massive expansion strategy. In 2008, the company was receiving
cash from customers 9 days prior to paying its own suppliers. Fast forward to
2014, and we see a complete reversal of nearly 4 weeks, as payment from
customers comes 18 days after the sale. That might not seem like much, but the directional
trend is very concerning.
Valuation
All of the above is easily enough for me to
consider MFRM as a short-sell investment, given the right price. So what is the
right price? Well we know that MFRM just announced their pending acquisition of
Sleepy’s. Their presentation shows the following valuation statistics for the
transaction.
So MFRM is paying $780 million for 1,066 stores –
equating to an enterprise value per store of $732k. Since MFRM has a strategic
interest in acquiring Sleepy’s (given synergy potential), it is logical that
MFRM would value Sleepy’s higher than any other potential buyer. This provides
a fresh, relevant data point for current market valuations.
The chart below shows historical valuation levels
for MFRM on a per-store basis. The 2016 estimated store count gives effect to
the 1,066 additional Sleepy’s stores (and the additional debt), and backs into
the implied stock value if MFRM as a whole were valued near the $732k
enterprise value per store.
So why would market enterprise values drop to the
levels indicated in the chart? Well the process has already begun, and I
believe the answer is leverage. MFRM shares are poised to end 2015 around $45.
This would mark the first calendar year end for MFRM’s valuation to fall below
$ 1 million per store. Given the increasing debt load and general credit
conditions, the Sleepy’s transaction valuation level around $730k-$735k EV per
store does not seem unreasonable. This would imply a $30 stock price, or
roughly 33% decline from current valuation levels around $45.
Disclosure:
author is currently short shares of MFRM
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