A Future Dividend King With Accelerating Payout Growth

With 46 straight years of dividend increases to its name, Leggett & Platt (LEG) is a dividend aristocrat and very close to becoming a dividend king, an even more exclusive club with members boasting 50+ consecutive years of payout increases.

What makes Leggett & Platt an even more interesting investment candidate is that over the past 30 years it has rewarded dividend investors with an impressive 10.8% annual payout growth rate.

Even more intriguing?

While many dividend aristocrats and kings are widely followed blue chips, Leggett & Platt is a relatively small and under-followed name.

So let’s take a look to see if Leggett is a potentially good long-term income growth investment, as well as whether now could be a reasonable time to buy the stock.

Business Overview
Founded in 1883 in Carthage, Missouri, Leggett & Platt patented the first steel coil bedspring.

Over 130 years later, the company is now a global manufacturer of furniture and furniture components (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.

Leggett & Platt operates 126 manufacturing facilities in 19 countries, serving a diversified customer base made up of some of the world’s largest companies.

Source: Investor Presentation

The company has four operating segments that include a total of 16 business units.

The vast majority of the company’s sales are derived from the U.S. market; however, Leggett also has a strong presence in overseas markets, including fast-growing emerging economies such as China.

Business Analysis
In order to maintain clockwork-like dividend growth for almost half a century, a company requires not only a stable and growing market for its products, but also a moat of some kind, meaning a competitive advantage that allows it to maintain pricing power, margins, and returns on shareholder capital over time.

Leggett & Platt’s strongest advantages are its long-standing customer relationships and reputation for quality (the company has been in the industry for over 100 years), its economies of scale as the largest player in the market (Leggett 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.

Leggett & Platt’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 and conservative capital allocation.

As the biggest player with vertically-integrated operations (Leggett owns its own steel rod mill and machinery, for example), Leggett & Platt 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, Leggett has successfully expanded the scope of its business well beyond bedding components with the help of acquisitions into a number of niches that offer higher growth and profitability.

In 1960, bedding components represented nearly 100% of Leggett’s sales. In 2016, the company’s revenue from bedding was just 20% of sales, underscoring the firm’s expansion into adjacent markets over the last 50+ years.

It’s also worth mentioning that Leggett & Platt’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.

However, demand for many of Leggett’s products is very cyclical, as you can see below.

While Leggett’s industry is highly cyclical, rising and falling with the global economy, the company has managed an impressive ability to steadily increase its profitability over time.

This rising profitability is a testament to management’s long-term efforts to diversify the company’s business lines into higher margin and faster growing industries over time.

That’s part of management’s long-term strategy, in which all its business units are broken down into four categories: growth, core, fix, or divest.

Specifically, management looks to only maintain operations in large (i.e. greater than $250 million) addressable markets, which are growing faster than global GDP and have the ability to generate 10+% returns on investment.

Over time Leggett & Platt has managed to turn itself into a gold standard of its industry, one with much better than average margins and returns on shareholder capital.

Leggett & Platt Trailing 12-Month Profitability

Sources: Morningstar, Gurufocus

The key to this success has been its quality management team, whose compensation is tied to strong and improving company fundamentals (returns on invested capital and free cash flow generation) and long-term total shareholder returns (TSR).

Specifically, Leggett’s long-term goal is to achieve total returns in the top 33% of the S&P 500, and management has proven that it has the disciplined and long-term focused capital allocation skills to usually hit its growth targets.

This includes prioritizing the spending of operational cash flow in the following way:

  1. Investing in organic growth of its top businesses (capital expenditure), with the goal of achieving large vertical integration and economies of scale
  2. Steady and secure growth of the dividend
  3. Growth through disciplined and accretive acquisitions
  4. Buying back shares with any excess remaining cash flow

Over time this thoughtful capital allocation plan has helped result in moderate sales growth over time, steadily expanding margins, and the stock meeting its goal of market-beating total returns.

Going forward management believes that its long-term strategy should be capable of generating 6% to 9% sales growth and 8% to 11% EPS and FCF per share growth.

Combined with a 50% to 60% Adjusted EPS payout ratio, this would likely allow Leggett & Platt to continue generating strong double-digit total returns (and high single to low double-digit payout growth) for the foreseeable future.

Key Risks
While Leggett & Platt’s impressive track record makes it among the best furniture manufacturers in America (and the world), there are nonetheless some important risks for current or prospective investors to consider.

First, Leggett’s business is sensitive to several macroeconomic factors that are beyond its control. Changes in raw material costs (e.g. steel) and consumer spending trends have materially impacted the company’s sales and earnings in the past, and they will 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 Leggett. Its operating margin is near its highest level since the late 1990s, and strong growth in automotive markets have helped fuel Leggett’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 Leggett & Platt’s business over the near term, they are admittedly less relevant to the company’s 10-year outlook.

However, the great majority of the company’s excellent returns in the past few years have come from substantial margin expansion, which has benefitted from a lot of low-hanging fruit that may not be as easy to replicate going forward.

For example, between 2014 and 2017 Leggett divested the majority of its store fixtures, wire products, and part of its commercial vehicle products (CVP) businesses.

In fact, the company’s business units have fallen from 28 to 17, as management attempts to move away from commoditized (i.e. low margin) sales and towards a greater focus on specialized products.

These include eight acquisition in the last three and a half years, including:

  • a high end private European manufacturer of premium upholstered furniture
  • a German designer and distributor of high-end, European-style motion furniture components
  • a U.S. manufacturer of aerospace tube assemblies
  • Tempur Sealy’s three U.S. innerspring production facilities

Leggett’s largest margin expansion has come from its greater focus on specialized components.

Note that the CVP group has now been divested, and its $40 million in annual revenue has been more than replaced by two new acquisitions that should generate $60 million in annual sales.

However, a potential problem for Leggett is that the specialized products segment is marked by far larger and better capitalized rivals than the much smaller furniture makers (Select Comfort, Tempur Sealy, La-Z-Boy, and Ethan Allen) that Leggett has historically been able to dominate through its vertical integration and better economies of scale.

For example, in certain specialty products segments, Leggett is competing with the likes the dividend aristocrat industrial legends Eaton Corp (ETN), PPG Industries (PPG), and even dividend kings such as Emerson Electric (EMR), Dover (DOV), and Illinois Tool Works (ITW).

Which means that maintaining its strong margins in those specialty businesses could be hard to do, especially since 75% of Leggett’s cost structure is variable and 55% of it is in the form of raw material costs that management has no control over.

Finally, we can’t forget that much of Leggett’s growth potential is overseas, both in Europe, where many of its most recent acquisitions are headquartered, but also in China.

As a result, Leggett could face steadily rising commodity risk, specifically during times when a strong U.S. dollar makes its products more expensive to foreign customers and can cost it market share, resulting in slower growth.

Leggett & Platt’s Dividend Safety
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

Leggett & Platt has a Dividend Safety Score of 65, indicating above average dividend security and dependability, which is what you’d expect from a future dividend king.

There are two main drivers behind Leggett & Platt’s solid dividend security.

First, management has been highly disciplined about maintaining a modest and safe free cash flow payout ratio to ensure that even during economic/industry downturns the dividend has a nice safety buffer.

You can see that Leggett’s free cash flow payout ratio has remained below 70% each year for more than a decade.

The other major protective factor is the company’s strong balance sheet and cash generation.

Specifically, tLeggett’s free cash flow last year covers both the cost of the dividend and its interest payments more than two times over.

And we can’t forget that this is a highly capital intensive industry, which means that to truly get a sense of a company’s financial strength we need to compare its debt metrics to those of its peers.

When we do, we can see that Leggett’s leverage ratio (Debt/EBITDA) is significantly below its industry average, while its current ratio (short-term assets/short-term liabilities) is much greater.

Combined with a very high interest coverage ratio, this explains the strong investment-grade credit rating that allows Leggett to borrow very cheaply (3.7% average interest rate).

Source: Morningstar, Fast Graphs

In other words, Leggett & Platt has plenty of financial flexibility that allows management to continue investing in future growth initiatives, without putting the safety or growth prospects of the dividend at risk.

Leggett & Platt’s Dividend Growth
Our Dividend 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.

Leggett & Platt has a Dividend Growth Score of 63, indicating that investors can expect above average payout growth in the coming years, (relative to the S&P 500’s 20-year median dividend growth rate of 5.9%).

That isn’t surprising given that Leggett’s dividend track record has been not only been very consistent with steady increases, but on the order of high single-digit growth over the past few decades.

In the next few years (2019), management expects to raise the dividend to $1.70 per share, which would represent 8.7% dividend growth and a nice break from the relatively slow growth of the last few years.

In the long-term, Leggett’s payout growth is likely to track its EPS and FCF per share growth closely since its payout ratio is unlikely to move higher.

Given that management believes that the company can leverage its 6% to 9% annual sales growth into 8% to 12% EPS and FCF per share growth (due to 1% margin growth and 1% to 2% annual buybacks), the company’s long-term goal of 8% to 11% dividend increases could be reasonable, assuming management can maintain Leggett’s strong margins over time.

Valuation
Over the past year Leggett & Platt shares have underperformed the S&P 500 by more than 20%, potentially making it one of the few reasonably valued dividend aristocrats (and future dividend kings) in the market.

For example, LEG’s forward P/E ratio of 18.6, while slightly above the S&P 500’s forward P/E of 17.7, is still lower than the industry median of 20.1, as well as the company’s historical P/E of 19.9.

Meanwhile, LEG’s dividend yield of 3.0% is higher than both the S&P 500’s 1.9% and the median 1.6% its peers are offering.

However, over the past 22 years, Leggett’s average yield has been 3.1%, which means that its shares aren’t necessarily undervalued today from a yield standpoint.

For those investors who believe management can continue to execute well on its long-term growth strategy, than Leggett & Platt should be able to generate long-term annual total returns of around 11% to 14% (3% dividend yield + 8% to 11% annual earnings growth). This makes it one of the few dividend aristocrats offering a double-digit total return profile.

Conclusion
When it comes to furniture makers, there is arguably no better choice than Leggett & Platt. After all, with 46 straight years of rising dividends, its high-quality management team has proven its ability to adapt to evolving industry conditions in both the U.S. and around the world.

That being said, it’s important for investors to realize that Leggett’s future strong dividend growth and total return potential is predicated on management being able to continue to compete well in a challenging industry (diversified specialty industrial components), where the company’s track record is far shorter and its core competencies may not transfer over as well.

With a valuation that appears reasonable based on long-term norms and the company’s future growth expectations, Leggett & Platt could be one of the few dividend aristocrats to consider. However, the best time to buy the stock would be during the next short-lived cyclical downturns in its end markets.

Investors seeking more income should review some of the best high dividend stocks here instead.

Brian Bollinger
Simply Safe Dividends

Simply Safe Dividends provides a monthly newsletter and a comprehensive, easy-to-use suite of online research tools to help dividend investors increase current income, make better investment decisions, and avoid risk. Whether you are looking to find safe dividend stocks for retirement, track your dividend portfolio’s income, or receive guidance on potential stocks to buy, Simply Safe Dividends has you covered. Our service is rooted in integrity and filled with objective analysis. We are your one-stop shop for safe dividend investing. Brian Bollinger, CPA, runs Simply Safe Dividends and previously worked as an equity research analyst at a multibillion-dollar investment firm. Check us out today, with your free 10-day trial (no credit card required).

Source: Simply Safe Dividends