The Motley Fool

This Undervalued Gem of a Retail Stock Is Just Too Cheap to Ignore

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Sleep Country Canada (TSX:ZZZ) has come full circle and is now trading below its 2015 IPO price of $17.

But since 2014, a lot has happened, and a lot of value was created by this company.

Revenue increased over 57% in this five-year period for a compound annual growth rate (CAGR) of 9.48%, the annual dividend paid to shareholders increased more than 42% for a CAGR of 7.31%, and cash flows have kept coming in strong.

So, what would you say if I told you that this is a retail stock that actually looks like it has a strong future ahead of it?

Would you be skeptical?

With Sleep Country Canada stock down almost 4% today at the time of writing after reporting weaker-than-expected results, I understand if you are.

So, this fall comes off the company’s reported first-quarter 2019 results, which showed another quarter of same-store sales declines and lacklustre earnings.

Same-store sales were hit partly by increasing competition in the space, mainly online competition, and earnings were hit by increased spending on Sleep Country’s own competitive positioning.

What I like

Revenue and earnings trends notwithstanding, Sleep Country continues to churn out cash flow, with strong free cash flow generation in 2018 ($41 million in 2018, or 6.5% of revenue) and again in the first quarter of 2019 ($15 million, or 10% of revenue).

The company has taken steps to increase its online presence, with the acquisition of mattress-in-a-box brands Endy and Bloom, its market share remains at over 20%, and this retailer’s opportunity to capture additional sales and market share as a result of the Sears closure here in Canada remain good reasons to own the stock.

What I don’t like

Clearly, the biggest issue here is the company’s same-store sales performance, which has been down in the last four or so quarters, placing into question the retail and competitive environment that Sleep Country is facing.

Final thoughts

To recap, I would like to draw your attention to the fact that Sleep Country currently pays us a healthy, well-covered dividend yield of 4.44%.

I would also like to draw your attention to the fact that in 2018, the company generated $623 million in revenue and in 2015, the company generated $456 million in revenue.

This retailer is trading at a P/E ratio of nine times this year’s expected earnings, two times book value, and operates in a segment of the retail environment that should be relatively stable and growing as Canada’s population continues to grow and as Sleep Country captures sales that formerly went to Sears.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Karen Thomas has no position in any of the stocks mentioned.

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