Leggett & Platt: This Dividend King Might Have Bottomed (NYSE:LEG)

Overview

With the classification of a “dividend king”, Leggett & Platt (NYSE:LEG) has a lot of pressure to maintain it’s 52-year dividend streak. LEG boasts a global presence with 135 manufacturing facilities across the world, and it operates within three primary segments: Bedding Products, Specialized Products (comprising automotive and aircraft components), and Furniture, Flooring, and Textiles. With a year worth of downward movement, estimated growth between 6% – 9% a year, and a dependable stream of income, we think this is a great opportunity to pick up a few shares.

Buying Opportunity

Presently, Leggett & Platt, Incorporated emerges as an attractive ultra-yield choice for investors to consider. Notably, the company’s yield has reached the higher end of the historical spectrum (excluding the sharp covid related drop), prompting an examination of its dividend safety. The current yield sits at an eye-watering 6.5% and is now too large to ignore.

Leggett & Platt experienced a substantial decline of free cash flow due to disruptions caused by the pandemic-induced supply chain challenges. However, the company adeptly managed this setback by implementing cost-cutting measures and rectifying the supply chain issues. This strategic approach facilitated a robust resurgence in free cash flow.

Using a DCF valuation method, we can input the following criteria to determine a fair value estimate. Using 2024’s estimated earnings per share outlook of 1.71, combined with management’s projected 6% growth rate, we can determine that the fair value of LEG sits around $31.23/share. This would represent an upside of 15%. When combining this with the 5% dividend yield, you are looking at double digit returns.

Cash Flow Dynamic

While Leggett & Platt’s annual free cash flow can display volatility, the company possesses the capability to sustain and further enhance its dividend by 3% to 4%, even during lean years. The company has survived many economic hardships in the past, including Covid, and I fully expect them to continue to manage their way through unsteady times. Reported for 2Q23, LEG reported $111M in cash from operations and an 11.2% EBITDA margin.

While they have consistently increased dividend payments for over 50 years, it’s important to acknowledge that a long-term payout ratio is extremely high at the moment. I recommend payout ratios of 60% or lower so this is something to consider and keep track of moving forward into the remaining earnings reports. Based on the 2023 estimate, we are looking at a payout ratio of 117%. This means the company is paying out more in dividends than they receive in cash.

Sales lowered to $4.75B, down 4% from the prior year. The decrease reflects continued volatility and instability on a macro scale and low visibility in several of LEG’s end markets. LEG expects to be down “mid to single high digits” in the bedding products segment but in the specialized products segment. On a more positive note, LEG has no significant maturities until November 2024.

Forward Looking Growth

Leggett & Platt allocates its cash resources according to these priorities:

1. Funding organic growth
2. Supporting the dividend
3. Facilitating mergers and acquisitions
4. Enabling share buybacks

The company’s management targets a growth rate ranging from 6% to 9% by increasing content and new programs, expanding market share, and through additional acquisitions. Some prior acquisitions consisted of hydraulic cylinders, geo components, and fabric converting.

The feasibility of Leggett & Platt’s growth and returns rests on the extensive opportunities within the U.S. bedding industry, coupled with the sizable addressable market in the automotive sector. LEG management has confirmed they have shifted to minimize acquisitions so that they can focus on debt reduction efforts.

We continue to deploy our cash in a balanced and disciplined manner. For the full year 2023, we expect capital expenditures of approximately $100 million to $130 million, dividends of approximately $240 million and minimal spending for acquisitions and share repurchases as we prioritize debt reduction in the near term.

Our long-term priorities for uses of cash remain unchanged. They include in order of priority funding organic growth, paying dividends, funding strategic acquisitions and repurchasing shares with available cash. As announced yesterday, we are lowering our full year sales and earnings guidance. 2023 sales are now expected to be $4.75 billion to $4.95 billion or down 4% to 8% versus 2022. – Ben Burns, Executive Vice President & Chief Financial Officer

Risk – The Dividend

Despite 52 years of consecutive dividend increases, there are understandable concerns. Presently, LEG possesses a comfortable liquidity reserve of almost $900 million. Additionally, its leverage ratio (debt/EBITDA) is gradually decreasing, expected to shift from 3.7 in the past year to an estimated 3.5 in the upcoming year. These metrics are a bit reassuring considering the extremely high payout ratio.

If the macro environment continues to be challenging, we could potentially see LEG fail to increase their dividend. Even worse, we may experience a dividend cut. Either way, this is the main concern for me as cash flow management is extremely important at this stage for LEG.

In addition, I think interest rates and their impact on the housing market play a significant role in the dynamics of LEG, a company engaged in the design, manufacture, and sale of products closely tied to the housing industry. When interest rates rise, the cost of financing a new home escalates, making homeownership comparatively more expensive. This situation can deter potential homebuyers, as accessing capital becomes less affordable. Consequently, this can have a direct and adverse effect on the demand for LEG’s products.

When people are faced with higher borrowing costs for housing, they are less likely to allocate their resources towards purchasing furnishings and related products. As a result, the demand for LEG’s offerings tends to diminish during periods of elevated interest rates.

Conclusion

Leggett & Platt, a renowned “dividend king” with a 52-year dividend history, operates globally with 135 manufacturing facilities spanning three core segments: Bedding Products, Specialized Products, and Furniture, Flooring, and Textiles. Despite recent declines, the stock offers a promising annual growth potential of 6% to 9% and an attractive 6.5% yield.

The current yield, near its historical high, indicates investment value. LEG adeptly managed pandemic disruptions, rebounding with robust free cash flow. Valued at approximately $31.23 per share in a discounted cash flow analysis, it presents a 15% upside alongside a 5% dividend yield.

However, a high long-term payout ratio, currently at 117% based on 2023 estimates, warrants attention. Additionally, macroeconomic uncertainties and rising interest rates could impact LEG’s dividend stability and product demand. Staying adaptable in the face of economic changes is essential for both LEG and its investors.