Mattress Firm Holdings Acquisitions Continue to Bolster Growth Amid Weak Industry Trends

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Mattress Firm Holdings Corp fourth-quarter results and the underlying 2014 outlook were in line with the company’s prea-nnouncement on February 18. While underlying industry trends remain muted (made worse by adverse weather conditions), increased acquisition activity is setting the stage for stronger growth once trends rebound and the company realizes further benefits from its market share strategy.

The company’s low-single-digit compstore sales expectation for 2014 would seem reasonable versus a similar level this past year, especially considering stepped up vendor advertising, although not back to historical levels; new product introductions; and improving consumer confidence. Based on the fourth-quarter experience, the question is how fast the company can pull back to its traditional selling model (i.e., less promotion) while sustaining optimal traffic levels. We believe this element creates some risk to the company’s outlook. Still, we believe the longer-term growth potential of the company remains compelling. Mattress Firm has an advantaged model that wins on all four attributes mastered by best-in-class retailers: convenience, assortment, price, and quality/service.

Fourth-quarter adjusted EPS of $0.28 (including $0.02 of ERP costs) declined 6% year-to-year and were in line with the company’s preannouncement on February 18. Note that our adjusted estimates include ERP costs as an operating expense, although we exclude acquisition costs. Comp-store sales increased 6.5% in the quarter, a sequential acceleration from 2.9% in the third quarter, although comps decelerated meaningfully on a two-year basis. The comp growth was composed of a 9.1% traffic increase offset by a 2.3% AUP decline.

The company did not see the magnitude of EPS flow-through because of a tougher consumer environment and inclement weather during the quarter, which resulted in further promotion to drive traffic and a deleveraging effect on marketing investments. Management quantified weather as a $7 million to $9 million negative impact. Gross margin of 36.7% declined 120 basis points versus last year and adjusted operating margin declined to 6.3% from 8.3% last year. The majority of the gross margin decline was driven by a product margin decrease of 250 basis points as a result of the company’s traffic-driving initiatives.

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