Sleep Country Canada Holdings (TSX:ZZZ) is Canada’s leading specialty sleep retailer with a solid omnichannel presence and five retail banners. In the last year, Sleep Country Canada’s stock, along with many others, has been challenged. With ZZZ’s stock price down 33% in the last five years but revenue up 50% in this same time, Sleep Country stock has never looked better.
Here are the reasons why I’m considering buying ZZZ stock.
An omnichannel solution for the sleep industry
Like so many other companies, Sleep Country has benefitted from population growth. But that’s not the full picture. Sleep Country’s success is also due to good execution, both financially and strategically. In fact, in the last few years, this company has transformed itself in order to change with the changing consumer.
This has translated into a large intricate presence, including an online, in-store, and mobile presence. It has also translated into strong revenue and earnings growth. In the last five years, revenue has grown 50% to $929 million, earnings have grown 85% to $110 million, and operating cash flow has grown 140% to $163 million.
ZZZ valuation is cheap, cheap, cheap
ZZZ’s stock price is trading at really depressed levels — a price-to-earnings ratio of eight times, and a price-to-cash flow ratio of a mere 4.8 times. Furthermore, Sleep Country Canada’s stock is also trading very inexpensively relative to its book value. You see, Sleep Country generates an extremely high return on equity (ROE). In the last 12 months, its ROE was 27%, as the company continues to operate at a very high level of profitability and efficiency. Yet ZZZ stock trades at only 2.1 times book value.
Clearly, something else is driving valuation — fears of recession and rising interest rates. While these fears are totally valid, as a recession would certainly hit Sleep Country’s business, the company is financially strong and able to withstand a lot. Its balance sheet is strong, with a healthy debt to total market capitalization of 49%. Also, its margins are strong, with a 12% profit margin in the last 12 months.
Buy ZZZ in the cyclical low period
Everybody needs to sleep. Most of us would invest to enable a better sleeping experience. Yet in the last quarter, Sleep Country experienced some weakness, as the challenging macro environment got to consumers. Revenue declined 10.4%, and earnings declined 19.3%, as consumers tightened their wallets. At the same time, armed with a strong balance sheet, Sleep Country continued its growth strategy.
For example, Sleep Country acquired Silk and Snow, one of Canada’s fastest-growing sleep companies. This company sells sustainable and affordable luxury bedding as well as bath products. Two things are notable here. The first is that Sleep Country is acquiring when industry valuations are low. This counter-cyclical approach is not easy to weather, but it often proves to be a great value generator. The second is that 25% of Silk and Snow’s revenue comes from the United States. It’s an exciting thing for Sleep Country to have some exposure in one of the biggest markets in the world.
Finally, there are also has some bright spots in this cyclically low period. Sleep Country’s accessories business is one of the bright spots, which posted a 9.2% revenue-growth rate for 2022 after an almost 30% growth rate in the prior year. The company commented on the fact that consumers are buying mid- to high-end accessories, which is a good sign for the consumer. Another positive aspect of this is that margins on accessories are 10 points higher than mattress margins.
In conclusion, I think ZZZ stock looks very attractive today, despite the challenges it faces, which I view as temporary.
