Leggett & Platt: It Is Worth Considering The Dividends

Introduction

Leggett & Platt, Incorporated (NYSE:LEG) designs, manufactures, and markets engineered components and products worldwide. It operates through three segments: Bedding Products; Specialized Products; and Furniture, Flooring & Textile Products.

We have published two articles about the firm on Seeking Alpha in 2022, and we had a bearish outlook for the company in both instances. The reason for our “sell” ratings were the overall state of the macroeconomic environment. We believed, and still believe, that the poor consumer confidence, the weak housing market, and the continuing inflationary pressures are likely to keep negative impacting LEG’s financial performance in the near term.

But today, we decide to take a look at LEG from a different perspective. We will be valuing the firm based solely on its dividends and dividend growth. As the stock is currently yielding 5.8%, many dividend and dividend investors may be wondering, if this stock could be a good addition to their portfolios. To answer this question, we will be using multi-stage dividend discount models, assuming a higher rate of dividend growth in the first period – in the next 5 years – and a lower, constant perpetual growth rate for the second stage – for the years beyond the first five years.

Why is this model suitable for valuation?

Before we go ahead with our valuation, we would like to point out a few important factors that we believe make LEG a suitable candidate to be valued by dividend discount models.

Over the past 3 decades, LEG has been committed to return value to its shareholders in the form of dividend payments. The firm has managed to pay dividends and even increase these payments in each year for the last 29 years. Companies that have a long history of paying and increasing their dividends are often good candidates to be valued by dividend discount models.

We also believe that these payments are likely to remain safe and sustainable in the near future, as LEG’s payout ratio is within its own historic range, even if it is on the high end right now.

We also have to mention however that firms, which are relatively sensitive to the business cycle may not be the best candidates. In our opinion, LEG is quite sensitive to the business cycle and its fluctuation, but because of its dividend payment history, we feel comfortable going ahead with our evaluation.

Assumptions

To come up with a realistic estimate, there are important assumptions to make regarding the:

• required rate of return, which we will use to discount the future dividends
• the dividend growth rates in the first stage – in the first 5 years
• the perpetual growth rate of the dividends in the second stage

The results are significantly influenced by these assumptions, especially by the perpetual growth rate. In dividend discount models, the terminal value makes up the largest portion of the fair value, and the perpetual growth rate influences this terminal value substantially.

Required rate of return

For the required rate of return, we normally prefer to use the company’s weighted average cost of capital (WACC). In LEG’s case, this figure is estimated to be between 6.8% and 9.2%, so we will go ahead with the average of 8%.

Dividend growth rates in the first & second stage

To come up with these estimates, we have to take a look at the company’s dividend history.

For our calculations, we assume that the firm will be able to keep its 4.8% dividend growth for the next year, but will gradually decline to 2.5%, which corresponds to the overall growth of the economy in the long term. We will be using this rate as the perpetual growth rate.

Results

Using these assumptions, our calculation yields the following results:

Based on our results, the firm’s stock appears to be fairly valued, as it is currently trading around $30 per share. To gauge, whether these results are realistic or not, let us take a look at some of the traditional price multiples.

By looking at these multiples, we get a similar feeling that LEG’s stock appears to be about fairly valued. Most of the multiples are close to both the sector median and also to the firm’s own 5Y average.

Based on these results, our view is slightly less bearish than it was in 2022. However, we cannot forget about the macroeconomic risks. For this reason, we will create another scenario, with more conservative assumptions to try to gauge, how much the stock would be worth if the near term, higher rate growth would not materialise.

Sensitivity analysis

For this case, we assume that also in the first stage the dividend growth rate will only be 2.5%, due to the poor consumer confidence and the weak housing market.

These results suggest that, even if the dividend growth rate will be only 2.5% in the near term, the potential downside is about 10% from the current price levels. We, however, believe that this is a relatively pessimistic outlook as we expect the macroeconomic environment to improve in the coming 5 years. The interest rates in 2-3 years’ time are not likely to be as high as today, which could have a positive impact on the demand for housing as the mortgages would become cheaper. Consumer confidence would also likely improve. These factors could eventually positively impact LEG’s financial performance and therefore potentially its dividend growth rates.

Key takeaways

Based our assumptions and the two stage dividend discount model, LEG’s stock appears to be about fairly valued. For this reason, our view from a valuation point of view is much less bearish than from a macroeconomic point of view.

Even, when assuming a constant dividend growth of 2.5% in perpetuity from today onwards, accounting for the near term macroeconomic uncertainty, the downside appears to be only about 10%.

For these reasons, we are rating LEG stock as a “hold” now.