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2019-11-08 16:01:05

Purple Innovation Inc. (NYSE:PRPL) designs and manufactures mattresses and related bedding items like cushions, pillows, and sheets. The products are recognized for having a unique design featuring its proprietary 'Hyper-Elastic Polymer' which Purple markets as based on advanced technologies to provide superior comfort . The company has been successful in driving sales for its direct to consumer online portal along with a growing wholesale distribution network through heavy advertising supported by positive customer reviews. Growth has been strong and accompanied by profitability this year. This article takes a look at the recent earnings release and why we think there is more upside for shares of PRPL.

(source: FinViz.com)

Purple Innovations Q3 Earnings Recap

Purple Innovation reported its fiscal Q3 earnings on November 6th with GAAP EPS of $0.16 compared to expectations of just $0.02, a beat of $0.14. Revenues on the quarter at $117.4 million increased by 66% year over year and also $12 million ahead of the consensus estimate. This was an otherwise blowout quarter for the company that is now on track for consistent profitability following years of recurring losses since and prior to its 2017 IPO.

(source: Company IR)

The story here has been ongoing sales momentum with firming margins. Most people in North America will be familiar with the Purple mattresses that have been a stable on TV commercials and online marketing campaigns for many years really driving home the message of the innovative technology.

(source: Company Website)

The result is that Purple is able to charge a relatively high premium for its product representing a high gross margin that reached 45% this past quarter from 39.7% in Q3 last year. The introduction of a new Hybrid Premier model in the past year has also supported growth and the gross margin. Separately, the operating expenses as a percentage of revenue fell to 35.7% compared to 44.6% last year, in part driven by a more moderate increase in marketing expense. Favorably this quarter, the company has been able to accelerate growth with less marketing and advertising.

In many ways, Purple has finally been able to deliver what it has been telling investors for a number of years, namely that the addressable market is much larger than present day sales and demand for the company's products will grow based on the quality of the product. Purple has been able to expand manufacturing capacity and add distribution channels through nationwide wholesale partners and the results have been positive. From the press release:

Following strong growth during the first half of the year, the pace of our business accelerated significantly in the third quarter, said Joe Megibow, Chief Executive Officer. We experienced robust demand for our differentiated product offering across our expanded network of wholesale partner doors and through our direct to consumer channel. Our outstanding top-line performance combined with improved efficiencies in our manufacturing, supply chain, fulfillment and marketing, along with a shift in certain marketing and human resource investments until later in the year fueled substantial gains in operating margin and profitability.

Full Year Guidance

Management is guiding for full-year 2019 net revenue in a range between $400 million and $425 million, adding that it expects a number towards the higher-end of that range. If confirmed, the full-year revenue estimate at the midpoint represents a year over year increase of 44% compared to 2018. Other points in the guidance are for the gross margin in Q4 to remain near a similar level to Q3 at around 45% while expecting a full year adjusted EBITDA forecast of $24 million to $27 million compared to negative adjusted EBITDA of $3.7 million last year.

PRPL Analysis and Forward-Looking Commentary

The number we are focusing on is the full-year adjusted EBITDA forecast around $25 million. Considering the Q3 EBITDA result at $15 million and taking that to an annualized $60 million rate for the year ahead, PRPL's current market cap of $475 million represents just 7.9x of annualized forward EBITDA. By our estimate the company also generated about $10 million in free cash flow during Q3 and we estimate the company can generate about $40 million in free cash flow next year representing a forward price to free cash flow ratio of about 12x.

We think these figures highlight the potential for significant upside for the stock price considering current market consensus estimates see Purple revenues growing by 22% in 2020 to $517 million and again 20% in 2021 to $620 million. Growth has upside here with an international expansion and the growing penetration in the North American market.

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Purple isn't necessarily unique with its business model of selling mattress direct to consumer as the trend really started about 10 years ago with a rise of these foam mattresses that are able to be compressed and rolled tightly to be shipped in a box. Notably, Purple faces competition from other brands such as privately held 'Casper Sleep Inc' which according to reports reached a $1.1 billion valuation with a Series D round of funding this past March and was on track to reach $550 million in revenues this year. Based on the same price to sales multiple, Purple could be valued at upwards of $800 million compared to the expected ~$420 million in sales for the 2019, representing 65% upside on a 2.0x P/S multiple.

Traditional spring-enclosed mattress giant Tempur Sealy International Inc (TPX) has also launched mattress-in-a-box models which remains still a small part of its annual $3 billion in sales and trades at a P/S multiple of 1.6x. By this measure PRPL, trading at a full year 2019 price to sales multiple of 1.1x, is about 45% undervalued. We are setting a price target for PRPL at $12.25 representing a more conservative P/S multiple of 1.25x on 2020 consensus sales, and 35% upside from the current level.

We think that the market is big enough globally for multiple bed in a box type companies and the Purple design is differentiated enough that represents a competitive advantage. Regardless of whether or not the Purple product is actually more comfortable or better , the company has proven to have mastered an effective marketing strategy with the current growth rates as a testament. The company has positioned itself as a premium brand and the strategy is working.

Risks

With a very strong near-term operating outlook the concerns here are farther out and relate to how Purple will deal with competition and what trends pricing will take. Investor monitoring points going forward should be the gross margin as a sign of market pricing power, with potentially weaker numbers reflecting a move towards discounting. The marketing spending is also an important metric for the company. The numbers this quarter showed Purple was able to pull back on the ad-spend while sales momentum still continued. We think moderating advertising and marketing spending will be a key component of driving earnings growth. Another risk to consider beyond a broad-based economic slowdown is that a potential expansion into new international markets may pose risks as the company may not immediately gain the same type of traction and could lead to an operating loss.

Takeaway

Purple's Q3 results represented a turning point for the company and will likely raise eyebrows for not only the headline 66% revenue growth but what is also looking to be a very impressive earnings growth story for the year ahead. The company's sales have accelerated driven by expanded manufacturing capacity and more widespread distribution through its wholesale partners beyond the original direct to consumer model. Purple has differentiated itself in what is admittedly a crowded mattress market with industry leading marketing supported by what is recognized as a quality product. We think the momentum will continue and see more upside for the stock. We rate shares of PRPL as a buy.

Disclosure: I am/we are long PRPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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