Investment Highlights
- Cash return is very high with a 3.3% dividend and 3.9% share repurchase over the last year
- Shares are near their 52-week high and trading at least 5% above fair value
- While earnings have improved, cash return may not be sustainable without significant improvement in operating costs
Leggett & Platt (NYSE: LEG) is a $5.3 billion manufacturer of furnishings for residential, commercial and industrial customers. Sales are closely linked to the rebound in U.S. housing which, though slower than many would like, is stable and should continue for the next several years. The company also books sales internationally, with 130 manufacturing facilities in 18 countries.
The company released a strong 3rd quarter earnings report recently, sending the shares to a new 52-week high. Earnings jumped to $0.51 per share, 31% higher against the same quarter last year. Sales grew 14% from the same quarter last year with growth across all segments. Residential furnishings outperformed with a 19% gain and accounted for 60% of total sales.
In July, Leggett & Platt announced that it would begin producing Tempur Sealy innerspring components for the company in a $48 million deal. The deal is a strong acknowledgment of the company’s competitive advantage in manufacturing due to its large size and broad manufacturing reach.
Fundamentals
Sales growth has been relatively weak lately though management estimates it can achieve around 4% annual growth over the long-term. The bigger problem over the last couple of years has been a big increase in operating expenses. The cost of running the company has increased 38% to $562 million in the last four quarters against $407 million booked in 2012. Some of the increase in operating costs in the most recent quarter were due to a $40 million settlement in an antitrust suit against the company related to its Prime Foam Products business, which was sold off in 2007 and shouldn’t be a problem going forward.
Despite weaker sales, the company’s financial health is stable with plenty of liquid assets to cover expenses. The company carries a sizeable amount of debt with 47% of the capital structured financed though rates are low and debt maturities shouldn’t be a problem.
Cash flow has also been a problem over the last year as the company maintains its commitment to shareholder cash return in the face of lower operating cash flows. Capital spending has been relatively consistent above $70 million annually over the last few years.
Dividends and Growth
Shareholder cash return is the bright spot for investors with a yield of 3.3%, only slightly lower than the five-year average of 4.2% due to strong stock price appreciation. The company’s payout ratio does worry me with $167 million paid out in dividends over the last four quarters against net income of just over $100 million. Granted, net income was lower from a write-off of assets in the amount of $172 million but weak operating results have been hitting income as well.
The dividend has increased by a rate of 3.7% annually over the last five years, well under the 13% average that management reports over the last 43 years. Leggett & Platt was founded in 1883 and has paid a dividend for 75 years.
The company has consistently bought back shares, returning $205 million to investors over the last four quarters. Rather than an authorized dollar value, the board has authorized a repurchase of up to 10 million shares annually.
Valuation
Shares are trading a little pricey at 22.5 times earnings over the last four quarters. Earnings are expected higher by 14% next year to $2.06 but that still leaves the shares at 18.6 times earnings.
On a discounted cash flow basis, the shares are trading just above fair value. In the table below, I am assuming that the company can maintain a 3.5% annual growth in dividends over the next four years. Over the longer-term, the company should be able to cut operational costs and could increase dividends by 5% annually.
There is a lot to like about shares of Leggett & Platt. The company is one of the few among the S&P Dividend Aristocrats to maintain its dividend yield above 3% and sales should continue to benefit from the slow rebound in housing. There is also a lot to be cautious of with high debt and runaway operational costs. The high amount of share repurchases and dividends may not be sustainable unless management can get control of costs and boost earnings. As a conservative investor with an eye to value, I would not be a buyer unless the stock came down to around $34 per share.
