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Seeking Alpha is full of experienced investors who are all pretty savvy when it comes to investing. But for just as many experienced investors, I'm sure there's plenty who are less experienced in search of stocks with attractive yields. Especially, when they're trading at a cheap price currently.
But what that inexperience may not tell you is it's probably cheap for a reason. One Dividend King that comes to mind is Leggett & Platt (NYSE:LEG). I've watched LEG over the years and was always attracted to their dividend track record and growth. But having randomly searched the stock the other day, my eyes couldn't help but notice the price. And in this article I'll discuss why although the yield remains attractive, due to cash flows projected to decline pushing their FCF payout ratio above 100%, Leggett & Platt is a stock I would avoid, at least for now.
I haven't looked into Leggett & Platt for a while now, but if my memory serves me correctly, the stock was trading near $40 a share last time I researched it. So, when I looked into it recently and saw it was trading near $20, the first thing I thought to myself was, maybe they cut the dividend?
But nope, the dividend and their track record is still intact, at least for now! For a new investor in search of a high-yield, there's a likely chance they'd look into LEG for a few reasons.
So, one might think the dividend is safe from a company like Leggett & Platt. But looking how the share price has performed over the past 1 & 5 years, that may be coming to an end. In the chart below, LEG's share price has performed poorly in the past year down nearly 40%.
Sure, interest rates have caused dividend stocks to become out of favor because investors can get a near 6% yield on a certificate of deposit or treasury bond. But if you look over the past 5 years, the stock is down almost 55%. So, even with dividends invested, you'd still be in the red if you held this stock.
And there will be times when your portfolio holdings will have periods of underperformance, i.e. REITs since 2022, but from a solid company like Leggett & Platt, you'd expect more. Especially, when you compare them to peers La-Z-Boy (LZB) and Ethan Allen Interiors (ETD).
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Looking at the chart above, you can see both peers are in the green up double-digits compared to LEG. So, one has to wonder why the former is doing poorly in comparison to the other two. Well, let's see why.
It's no secret that businesses, even the more known ones had trouble in 2023 due to the challenging economic backdrop. The main reason for that was interest rates. And now that we're in 2024 some are still feeling the effects. The cost of borrowing and products have skyrocketed. Operating expenses have also increased dramatically, which all cut into business financials, or profits.
For the entire year 2023, LEG's earnings payout ratio has been elevated above 100%, the first red flag and not something you want to see from any business, let alone a company in your portfolio. However, these issues can happen and although they are unexpected sometimes, as an investor, this is something I want to only see temporarily. Maybe a quarter or two? Anything after that I start to get skeptical.
During their Q4 earnings reported February 9th the company posted a miss by $0.01 on earnings per share of $0.26 and a beat on revenue with $1.12 billion. EPS was down year-over-year by 33% from $0.39 in Q4 '22 and Q1 '23.
As you can see in the chart below EPS declined steadily quarter-over-quarter from $0.39 to $0.26, something you don't want to see from a Dividend King. Sure, the economic backdrop has created disruption and financial instability for consumers, but a steady decline in financials is concerning. EPS was $2.27 in 2022.
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Changing consumer habits from the challenging economic backdrop along with market dynamics, particularly within LEG's residential end markets, have caused their bottom line to be in a secular decline. In short, consumers are spending less. Additionally, the macro environment has created disruptions for LEG customers, ultimately creating low demand for some products, particularly in the Bedding segment. Furthermore, costs of goods & services have increased with the rise in interest rates.
For the full-year sales declined 8% to $4.7 billion, primarily driven by weaker demand in the market and raw material related issues. Adjusted EBITDA was also down 5.9% vs 7.6% the year prior.
In the segments, 2 of the 3 were down with Bedding down 14% for the quarter and 17% for the full-year. Sales in Furniture, Flooring, & Textile were also down 11% for the full-year while sales in LEG's Specialized products increased 5% from Q4 '22 and 14% for the entire year.
And to add salt to the wound, management's guidance for 2024 didn't help the company either. EPS is expected to be in a range of $0.95 - $1.25 for the full-year with a $0.20 to $0.25 impact for restructuring costs. With lower volumes in the Bedding & Furniture segments.
Although interest rates are expected to decline, I anticipate management is being conservative to manage shareholder expectations as consumers will likely continue facing financial instability, leading to lower demand and volumes for the company.
Furthermore, global steel costs and metal margin compression are expected to affect the business going forward as well. Even with strong demand expected for the aerospace business with backlogs at historic highs, this is not enough to offset the projected decline. However, management could increase guidance in the coming quarters as they get more visibility and data regarding interest rates.
On top of the weak earnings guidance, cash flow is also expected to come in significantly lower than 2023's $497 million. And although this did increase from $441 million the year prior, 2024 is expected to be $240 million after capital expenditures.
And even though the company managed to cover the dividend in 2023 with a safe FCF payout ratio, the upcoming year is expected to be above 100% according to management's guidance.
Of course, this could change if the company manages to exceed expectations. A lot can happen between now and the end of the year. Rates are expected to decline which should impact consumer spending habits positively. This will likely cause operating expenses to decrease as well.
The company paid out $239 million in dividends for 2023 which their free cash flow of $383 million safely covered, giving them a free cash flow payout of 62.4%. But as previously mentioned, their cash flow is expected to drop by a sizable margin this year.
LEG investor presentation
The company also expects to make minimal acquisitions and buybacks so using the projected share count of 138 million, this means they need minimal free cash flow of roughly $254 million to cover the dividend if it remains the same. Leggett & Platt raised the dividend by 4.5% back in May to $0.46 and because of their prestigious record as a Dividend King, they will try to keep the streak going for as long as they can.
But for how long remains to be seen. If I were management I would hold the dividend here while the company gets more visibility on the economy going forward. A dividend cut to free up cash flow is also a real possibility. Quant currently rates the stock a sell with a Dividend Safety grade of F. And until the company shows more promise in their financials in the foreseeable future, I see this continuing for the near term.
Leggett & Platt currently has a P/E of roughly 15x, slightly above the sector median of 14.74x. They also trade 8% lower than their 5-year average, further signaling the stock is undervalued at the moment.
However, this is currently higher than peers Ethan Allen's 10.63x and La-Z-Boy's 12.66x. Although analysts expected LEG's earnings to decline for the year, they are expected to get back to growth in 2025 with an average growth rate of roughly 6.5% over the next 4 years. But, of course, this is all dependent on how the company fares in 2024. Analysts have a price target of $19.67 for the stock, roughly $1 downside at the time of writing.
Using the Discounted Cash Flow Model and an expected growth rate of 3% to manage expectations. I also use 9% expected return since the S&P historically averages returns of 7% - 10%. This brings me to a fair value of $23.86 for LEG, roughly $3 higher than the current price.
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Right now the biggest risk for Leggett & Platt is the company's prestigious record as a Dividend King. They've operated for a very long time and although the dividend was safely covered for 2023, it remains shaky in 2024. Unless the economic backdrop eases and cash flows come in higher than expected, I see continued downward pressure on the share price in the near term.
If the company does cut the dividend, then I do see some slight downside from here, although minimal as I think the risk of a cut is already priced in here. Investors currently holding LEG should keep a close eye in the coming months as the stock could see further volatility due to uncertainty surrounding their King status.
Due to their lengthy track record and near 9% yield currently, LEG may look like a compelling buy here. Especially, when you consider the cheap valuation along with the annual payout. However, shareholders must be aware that although they are a Dividend King, past performance doesn't predict the future. And unless cash flow comes in higher than expected, LEG's FCF payout ratio is projected to be above 100%.
I expect the company to hold out as long as they can and may even continue to raise the dividend in the coming months, but unless management makes or expects a drastic change to optimize their free cash flow, the dividend is at high risk of being cut. 2023 was underwhelming to say the least but they still managed to safely covered the dividend with free cash flow. But due to a projected payout above 100% and risk of a dividend cut, I rate the stock a hold.