Don't Hit the Snooze on the Sleep Number Pullback

After climbing for 12 straight months, Sleep Number (NASDAQ:SNBR) is finally taking a rest in April 2021. With the stock now trading roughly 18% below its $151.44 intraday high, investors should stay alert for a buy opportunity.

Sleep Number hasn't had a meaningful correction since rallying from less than $20 a year ago so it was certainly overdue. But given the strength in the business and the company's growth plans, there may not be another pullback of this magnitude for some time.

After the market close on April 21^st, Sleep Number reported first quarter numbers that should get traders up out of bed.

 How Did Sleep Number Perform in Q1?

Sleep Number has a tough act to follow in 2021 after posting 81% EPS growth last year. But so far, the encore performance is off to a good start.

First-quarter sales increased 20% to $568 million. The top-line growth would've been stronger had two weeks, or $50 million, worth of deliveries not been shifted into the current quarter due to a foam supply constraint.  

Diluted earnings per share were far from soft. They increased 85% to a record $2.51 which not only is an acceleration from last year but handily surpassed the Street. The consensus EPS estimate was $1.79 so this marked yet another big earnings surprise, a result the market has almost come to expect.

The strong start to the year gave Sleep Number management the confidence to boost its full-year outlook. It now sees 2021 EPS of at least $6.50, a 50 cent increase over the previous guidance. This would represent 40%-plus year-over-year profit—not a bad follow-up to last year's performance.

What are Sleep Number's Growth Prospects?

Over the last five years, Sleep Number has recorded annualized EPS growth of 34% which is clearly abnormal growth in the furniture industry. Due to the high margin nature of its premium, tech-enabled beds, it boasts a 7.5% net profit margin that traditional furniture manufacturers could only dream of.

Although earnings growth is likely to moderate over the next few years, Sleep Number should still be able to generate some solid returns for shareholders. This is because it has successfully tucked itself in to the niche, but fast-growing smart bed market. It is an area that is quickly becoming a bigger part of the broader $21 billion mattresses and bedding market.

Whether it be clothing, cars, or home décor, consumers are increasingly craving customized goods. For many, bedding is no different—and Sleep Number's 360 adjustable smart beds are worth paying for to have a personalized sleep experience complete with a SleepIQ score. At the same time, people have a greater appreciation for the value of sleep in a stressful, pandemic-ridden world. So, combine the customization trend with the health and wellness trend and Sleep Number seems to be in a comfortable position for growth.

Next year the company will launch its new Climate360 smart bed setting out to solve Americans' issues of being too hot or too cold during sleep. The mattress is said to use advanced temperature technology that knows when to warm the feet and when to cool the body. It remains to be seen it consumers will warm up to this high-ticket item.

Beyond the present tailwinds, Sleep Number is turning to investment in digital technology to drive the next wave of growth. Its current digital ecosystem has been a powerful force behind generating consumer interest and engagement. Spending on new science-based digital tools will remain a key part of the growth strategy going forward.

To capitalize on growing consumer interest in digital health solutions, Sleep Number plans to go beyond the sleep health market and into the much larger connected health market. This could double its addressable market into areas like disease prevention and health monitoring. If the company can make inroads in the connected health space, it could generate some healthy new revenue streams—and become less dependent on selling pricey smart beds.

 Is the Sleep Number Pullback a Buy Opportunity?

Sleep Number shares are neither expensive nor cheap. They certainly aren't as expensive as they were in early March 2021. The forward P/E ratio of 30x may be worth the premium valuation given the growth outlook for fiscal 2021. With analysts expecting the company to grow its bottom line by 25% this year and another 10% next year, it may be growth worth paying for.

Unfortunately, hedge funds have grown tired of Sleep Number in recent quarters. Four different hedge fund managers reduced their holdings in the fourth quarter, and it wouldn't be surprising to see further reductions reported for Q1 when the stock went from roughly $80 to $140.

Insider trading activity has also been on the bearish side of late. Over the last three months, more than $8 million of sells have been executed by corporate insiders. Earlier this month, director Jean Michel Valette parted with $3.4 million worth of Sleep Number shares prompting the stock's April swoon.

So, Sleep Number isn't quite a screaming buy here given the reasonable valuation and recent insider selling. But given that the company continues to report huge quarter after huge quarter, it's hard to imagine that the long-term trend isn't up.

Investors will want to keep this one on the watch list. If the stock starts dipping into the $100 to $110 range, it may be time dial up Sleep Number.