With operations dating back to the 19th century and a 3.1% dividend yield, LEG is an interesting company for dividend investors to analyze.
LEG was founded in 1883 and patented the first steel coil bedspring. Over 130 years later, the company has grown into a diversified manufacturer of a broad variety of engineered components and products (e.g. innersprings, recliner mechanisms, adjustable beds, steel wire, seat frames, carpet cushion, armrests, etc.) used in bedding, furniture, carpet, cars, planes, and more around the world.
By end market, 21% of LEG’s 2014 revenue was bedding, 16% fabric / carpet cushion, 15% automotive, 15% steel wire, 11% furniture, 7% consumer products, 5% work furniture, 3% aerospace, 3% steel tubing, 2% machinery, and 2% commercial vehicle products.
Overall, LEG’s pegs its macro market exposure as follows: 55% consumer durables, 25% commercial / industrial, and 20% automotive.
By geography, approximately 69% of LEG’s production was in the United States, 11% in Europe, 10% in China, 6% in Canada, and 4% in other countries.
After learning more about LEG and its industry, coming up with the competitive advantages that have driven the company’s outstanding long-term performance was still challenging. We believe that the company’s management team has done an excellent job managing the business, and it’s worth mentioning the incentive system in place.
LEG’s management team receives bonus compensation that is based on incentives targeting annual return on capital employed, growth in margins, and achievement of a 3-year total shareholder return in the top third of the S&P 500. Insiders also own more than 10% of LEG’s outstanding shares, further aligning their capital allocation decisions with the best interest of the company’s shareholders. The company’s culture has certainly helped its longevity.
Back to LEG’s actual operations, its strongest advantages are its long-standing customer relationships and reputation for quality (LEG has been in the industry for over 100 years), its economies of scale as the largest player in the market (LEG is also vertically integrated), its focus on innovation to improve profits and growth, and its global distribution system.
Manufacturing components used in mattresses, furniture, cars, and other products is usually a tough business. Buyers are focused on keeping their costs low, and many components can easily become commoditized and purchased for less overseas.
LEG’s entry into its key markets many decades ago helped it acquire number one or number two market share positions, which it has successfully maintained through innovation (LEG has issued over 1,300 patents) and conservative capital allocation. As the biggest player with vertically integrated operations (LEG owns its own steel rod mill and machinery), LEG is often one of the lowest cost providers of its products. It has also developed innovations to adjust to shifting market trends, including adjustable beds and a “Comfort Core” innerspring used in hybrid mattresses that replaces traditional foam cores and innersprings.
Beyond product innovation and cost efficient operations, LEG has successfully expanded the scope of its business well beyond bedding components with the help of acquisitions. For example, LEG formed its Aerospace Products business unit with the acquisition of Wester Pneumatic Tube, a leading provider of integral components for critical aircraft systems, in January 2012. The company has also increased its focus on automotive markets (15% of sales), helping grow its global content per vehicle by 50% since 2009.
Through acquisitions, LEG has diversified its business into a number of niches that offer higher growth and profitability. In 1960, bedding components represented nearly 100% of LEG’s sales. In 2014, the company’s revenue from bedding was just 21% of sales, underscoring LEG’s expansion into adjacent markets over the last 50 years.
Finally, LEG’s markets are generally slow changing in nature. The problems solved by mattresses and furniture are timeless, and about two-thirds of bedding and furniture purchases are made to replace existing products. This is a mature market with low-single digit growth. The manufacturing processes and materials used to produce these goods are evolving (e.g. foam mattresses) but at a mild pace.
LEG ultimately targets 4-5% annual revenue growth and consistent margin improvement driven by cost savings, new product development, and modest market growth.
Leggett & Platt’s Key Risks
LEG’s business is sensitive to several macroeconomic factors that are beyond its control. Changes in raw material costs (steel) and consumer spending trends have materially impacted LEG’s sales and earnings in the past, and we expect them to remain important factors going forward over short-term periods.
The best time to buy macro-sensitive stocks is when demand is weak and sentiment around the business is overly pessimistic. This is not the case with LEG. Its operating margin reached its highest level since 1999 last quarter, and strong growth in automotive markets have helped fuel LEG’s sales growth over the last five years. Additionally, sales of existing homes have been very strong, generating decent demand for mattresses and furniture.
While these factors impact LEG’s business over the near term and seem to indicate lower timeliness for the stock today, they are less relevant to the company’s 10-year outlook.
Our primary concerns with LEG are its margins. As a component supplier to price-sensitive markets like furniture and automobiles, LEG’s customers are always looking to save costs. With the bulk of its production in the U.S., it’s hard to imagine LEG maintaining a cost advantage over international players with cheaper labor, resources, and currencies.
Many of LEG’s customers could also be forced to relocate or outsource more of their furniture and mattress manufacturing overseas to remain competitive in an increasingly global economy. LEG doesn’t have nearly as large of a manufacturing footprint outside of the U.S., which represented about 70% of its capacity last year, and could gradually be left behind with underutilized factories.
LEG’s sprawling operations could eventually come back to hurt the company as well. LEG has 18 business units, which is a lot to manage and try to be great at. If the company loses focuses or has to reorganize, it could erode some of LEG’s advantages. However, its business diversification also protects it from missing out on consumer trends, such as the move to memory foam mattresses.
It’s also worth noting that LEG’s top 10 customers accounted for 27% of its sales – if a major customer decides to source its components somewhere else or fundamentally change a product, LEG could experience a near-term earnings hit.
Dividend Analysis: Leggett & Platt
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. LEG’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
We think LEG’s dividend is reasonably safe and have assigned the company a Dividend Safety Score of 66. While the company is somewhat cyclical and has slightly above-average payout ratios, it is a great free cash flow generator in practically every market environment.
LEG’s earnings and free cash flow payout ratios over the last 12 months are 68% and 57%, respectively. LEG’s earnings payout ratio was impacted by non-cash goodwill impairment charges in recent years, so we will look at the company’s free cash flow payout ratio instead. As seen below, LEG’s payout ratio has increased a bit over the last decade but has otherwise remained between management’s 50-60% target for most of the last five years, providing some cushion (no pun intended) and room for modest growth.
As we mentioned, LEG’s business does have some cyclicality to it. During the last recession, LEG’s sales fell by 25% in fiscal year 2009 as consumers put off big ticket discretionary purchases like furniture and mattresses.
Despite the cyclicality of LEG’s revenue, the company is a free cash flow machine. Even during the worst of the financial crisis, LEG easily generated enough free cash flow per share to cover its current annual dividend payment ($1.28 per share). As a matter of fact, LEG’s free cash flow has more than covered the company’s dividend payment for over 25 straight years, adding to the dividend’s safety.
The company has also generated a decent return on invested capital each year despite the competitiveness of its markets. The company’s scale, vertical integration, and efficient operations have helped it create value for shareholders.
Finally, it’s very important to scrutinize the balance sheet for cyclical businesses. No one has a crystal ball, and macro conditions can quickly turn when management least expects it. If a company like LEG found itself with reduced cash flow and heavy debt or interest payments needing to be paid, the dividend could become at risk.
As seen below, LEG’s balance sheet is reasonable. The company has enough cash ($251 million) to cover its dividend payments and interest expense, and its free cash flow generation safely covers both items as well. All of the company’s book debt could also be covered with cash on hand and 1.7 years of earnings before interest and taxes (EBIT).
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
LEG’s dividend growth potential is somewhat below average with a Dividend Growth Score of 43. The company has been a very reliable dividend grower with 44 consecutive years of increases, including a 3% raise in August 2015, but this dividend aristocrat has seen its growth decelerate over the last decade.
As seen below, LEG’s dividend compounded by 7.2% per year over its last 10 fiscal years, but growth has slowed to about 3% per year more recently. The company targets a 50-60% payout ratio, which is right where it sits today. Going forward, we expect low-single digit dividend growth to continue but wouldn’t be surprised to see LEG reach dividend king status in six years.
LEG trades at about 18x forward earnings and has a dividend yield of 3.1%, which is lower than its five year average dividend yield of 3.9%.
We view LEG as a well-managed business, but we don’t perceive it to have a substantial moat or long runway for earnings growth. For those reasons, we aren’t overly excited about the company at 18x earnings and a dividend yield that is below its historical average.
However, management has done an excellent job of meeting the company’s target to achieve a total shareholder return in the top one-third of the S&P 500. For the three-year period that ended on 12/31/15, LEG delivered a 23% annualized total return, which placed it in the top 29% of the S&P 500.
Management targets an annual total shareholder return (TSR) of 12-15% as follows:
- 4-5% TSR from revenue growth (half from GDP growth, half from acquisitions / share gains / new products
- 2-3% from EBIT margin improvement (20-30 basis points annually)
- 3-4% TSR from dividend yield
- 2-4% TSR from lower share count (via stock buyback)
Given our valuation concerns and lower conviction in LEG’s business quality, we would prefer to wait for a cyclical downturn in the company’s markets before getting more interested.
LEG appears to be a well-run business that has made the best of its positioning in very competitive markets. We believe the company’s dividend payment has above average safety characteristics but below average growth prospects. While we aren’t interested in buying the stock for our Top 20 Dividend Stocks portfolio today, we will keep an eye on it as we await an inevitable cyclical pullback.
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