In part 23 of the 54 part Dividend Aristocrats In Focus series, I take a closer look at the growth prospects and competitive advantage of home, business, steel wire, and specialized product manufacturer Leggett & Platt (LEG, Financial). The company was formed in 1883 and has increased its dividend payments for 43 consecutive years, dating back to 1971. Leggett & Platt has realized its 4+ decade dividend growth streak by operating in the relatively slow changing furniture industry. The company’s operations are analyzed in detail below:
Business overview
Leggett & Platt operates under four distinct business segments: residential furnishings, industrial materials, commercial fixturing and components and specialized products. Each segment will be analyzed below including the percentage of total revenue each segment contributes to the overall company to paint a clear picture of Leggett & Platt’s business model.
The residential furnishings segment is by far the company’s largest, accounting for 48.5% of total revenue and 59.9% of total EBIT for Leggett & Platt in 2013. The residential furnishings segment produces spring and coil mattresses, beds and bedding accessories, recliners and sofas and carpet underlayment.
The company’s industrial materials segment is its smallest based on revenues and EBIT. The segment generated 11.2% of total revenue and 5.2% of total EBIT for the company in 2013. The segment primarily produces steel rods and steel wire.
The commercial fixturing and components segment generated 20.8% of revenue and 25.4% of EBIT for Leggett & Platt in 2013. The segment manufactures product displays, point-of-purchase displays, and office furniture for businesses. The commercial fixturing and components division is the company’s second largest based on both EBIT and revenue.
Finally, the specialized product segment manufacturers parts and components for the automotive industry and bedding and mattress industry. In addition, the segment produces wireless charging technology under the Helios name. The specialized product segment generated 19.5% of revenue and 9.4% of EBIT for Leggett & Platt in 2013.
Competitive advantage
Leggett & Platt has diversified its manufacturing over the last decade, but is still predominantly a U.S. manufacturer. The company generated 72% of sales from products manufactured within the U.S. in 2013. Out of the company’s 131 manufacturing facilities, 85 are located in the U.S. The image below breaks down the company’s manufacturing facilities by segment and geographic location
Source: 2013 Annual Report
Leggett & Platt has a competitive advantage in spring mattress manufacturing and related industries, specifically in the U.S. Mattresses have high transportation costs due to their large size, giving local manufacturing a pricing edge over foreign competition. The bulkiness of mattresses has preserved Leggett & Platt’s spring-based mattress competitive advantage in the U.S. despite more economical manufacturing overseas.
Growth prospects
Leggett & Platt’s competitive advantage in innerspring mattress manufacturing is very focused. The mattress industry has evolved over the years, and Leggett & Platt has not kept pace despite holding over 1,200 patents and trademarks. Memory foam mattresses have eroded the company’s growth in the U.S. Cheaper international manufacturing has damaged the company’s position in home and office furniture, resulting in over a decade of stagnant growth. Leggett and Platt had sales of over $5 billion in 2004. For the full year 2013, the company generated about $3.75 billion in sales. Leggett & Platt’s 10-year revenue has declined substantially. The company has repurchased shares at a fast rate, but even revenue per share was higher in 2005 than it was for the full year 2013.
Despite weak long-term trends, management expects to grow revenue at 4% to 5% annually. To their credit, revenue has grown since the recession of 2007 to 2009. The company expects to generate a compound annual growth rate for shareholders of between 12% and 15% per year through revenue growth (4% to 5%), margin growth (2% to 3%), dividend yield (3% to 4%) and share repurchases (2% to 4%). Obviously, margins cannot and will not grow at 2% to 3% forever. The company cannot fully control its revenue growth rate, and long-term trends are unfavorable. Overall, I am very skeptical of management's long-term 12% to 15% target growth rate due to the very bullish revenue projections and margin growth. I believe the company can generate long-term returns of 4% to 9% for shareholders from dividends (3% to 4%), share repurchases (2% to 4%) and revenue growth (-1% to 1%). The company is operating in highly competitive industries with negative long-term trends. I do not believe margin enhancement will continue indefinitely, and long term growth has historically been negative for the company (over the last decade), not positive.
Recession performance
Unlike many other dividend aristocrats, Leggett & Platt did not perform well through the Great Recession of 2007 to 2009. The company’s EPS from 2006 to 2010 are shown below to show how the recession impacted Leggett & Platt:
- 2006 EPS of $1.57
- 2007 EPS of $0.28
- 2008 EPS of $0.73
- 2009 EPS of $0.74
- 2010 EPS of $1.15
The company did not reach new EPS highs until 2012, 5 years after the start of the recession. Leggett & Platt maintained a payout ratio of greater than 100% from 2007 through 2009. If a protracted recession occurs, it is unlikely Leggett & Platt will be able to maintain its dividend payments.
The company performs poorly during recessions because it sells products that consumers can ‘wait on’ until their economic situation improves. As a result, earnings drop precipitously as the company has a difficult time moving its inventory.
Dividend analysis
Leggett & Platt currently has a dividend yield of 3.6% and a payout ratio of around 73% using earnings estimates for full 2014. The company’s high payout ratio gives it little room to increase its dividend payments faster than overall company growth. The company has about $8 per share in debt with $2.2 per share in cash. If another protracted recession occurs, Leggett & Platt will be in danger of reducing its dividend payments and falling off the dividend aristocrat list.
Valuation and final thoughts
Leggett & Platt currently has a PE ratio of about 21.7. The company is trading at a higher multiple than the S&P 500 which currently has a PE ratio of about 18. Despite unfavorable growth prospects and poor performance during recessions, Leggett & Platt has historically traded at a premium to the S&P 500’s PE ratio. I believe this is unwarranted despite the company’s long history of dividend increases. Times change, and the company’s competitive advantage has weakened substantially over the last decade.
As a result, I believe Leggett & Platt should trade at a discount to the S&P 500’s PE ratio. A 0.9x multiple offsets the company’s poor growth prospects and risks ahead. At a 0.9x multiple, shares of Leggett and Platt should trade at a PE multiple of around 16 at current market prices. I believe the company is currently significantly overvalued and has significant downside with limited upside.
Leggett & Platt has a high dividend yield which may be enticing to investors seeking current income. I believe there are significantly better dividend aristocrats that have higher yields such as Philip Morris International (PM, Financial), Altria (MO, Financial), and McDonald’s (MCD, Financial). Due to the company’s poor growth over the last decade, Leggett & Platt ranks in the bottom 20% of stocks based on the 8 Rules of Dividend Investing.
