Leggett & Platt: More Than Meets The Eye

Background

Founded in 1883 and headquartered in Carthage, Missouri (population 15,000), Leggett & Platt (NYSE:LEG) is part of an old breed--a manufacturer who has withstood the test of time and makes a number of things which are utilized by millions of consumers each day, of which almost none would recognize the name of the company whose products they utilize.

With 135 manufacturing sites worldwide, the company operates in three main segments--Bedding Products (mattress springs, wires, foam, private label mattresses, etc.), Specialized Products (a hodgepodge of automotive and aircraft parts as well as hydraulic cylinders), and Furniture, Flooring, and Textiles (furniture for work and home, as well as flooring materials).

As of this writing, the company pays a dividend with a current yield of 5.62%, which is good given that the stock has broadly underperformed the market over the last ten years.

On a price appreciation basis, Leggett has delivered negative 4.3% for investors, while the broader market has returned 150%. Things are a bit better (just a bit) on a total return basis, where Leggett has delivered a 37% return over the same time frame compared to the S&P 500's (SPY) roughly 200% return.

Of course, investors in Leggett & Platt aren't likely looking for a grand slam of price appreciation--a typical investor in the company is likely seeking yield and looking for stability.

It is through that lens that we will approach Leggett & Platt and analyze whether we think the company is set to maintain course for yield-seeking investors. Let's dive in.

Results & Outlook

The company recently announced its Q1 results, with Bedding making up roughly 40% of the company's reported $1.2 billion revenue, while Specialized Products and Furniture each brining in roughly 30% (Specialized Products was boosted by the August 2022 acquisition of a heavy equipment hydraulic cylinder manufacturer).

Despite revenue being down 8% year over year, the report beat analyst top line estimates by almost $25 million (which could, again, have been influenced by the cylinder acquisition).

To this end, we turn to the margin profile of Leggett's underlying businesses for Q1 and consider management's guidance going forward.

We'll first note that EBIT in total fell by 35% year over year, and overall business margin fell by a comparable amount from 10.4% to 7.4%. Looking a little closer reveal that the Bedding Products unit suffered the most, with EBIT falling by 56% year over year.

This is due to the largest cost of Leggett's chief bedding input: steel.

In the Q1 earnings call, management addressed the margin concerns in detail. Outlining the core problem, CEO Mitch Dolloff stated that "we anticipate metal margin to be down mid-teens versus 2022. However, we also expect rod pricing and metal margin to remain at historically elevated levels due to higher conversion cost."

This is, of course, a problem, especially since earlier in the call it was stated that steel production levels are down. This dual threat of reduced production and higher cost, then, represents a double-whammy of challenges facing Leggett's bedding business in the near term.

Rising costs have prompted management to begin unloading inventory. While the last quarter brought positive movement, we note that Leggett's days inventory outstanding [DOI] remains stubbornly elevated on a historical basis.

Days inventory outstanding is a useful metric by which to evaluate inventory levels because it accounts for sales against inventory and can thus detect anomalous patterns. In recent years, as we can see, Leggett's days inventory outstanding has surged from roughly 65 days on average between 2016-2019 to the mid-80s today.

While we are pleased to see the quarterly DOI fall in the most recent report, there seems to be more work to do on management's part to restore the balance to historic levels.

The Dividend

A large portion of Leggett's attraction to investors is its dividend. The company paid out $58.3 million in dividends in the first quarter to shareholders, and as of this writing the stock's current dividend yield is 5.8%. In our view, shareholders may have reason to be a little nervous about the status of the dividend going forward if business conditions do not materially improve.

Net earnings from Leggett's income statement totaled $53.5 million. Adding back depreciation and amortization of $27.4 and $18 million, respectively, brings us to adjusted operating cash flows of $98.9 million.

Of course, this does not seem like a problem--dividend payments of $58 million are easily covered by cash flows of $98 million (or the company's reported $96.7 million, for that matter).

However, we are made cautious by the company's participation in the selling of trade receivables. While this is a perfectly normal practice which many business participate in, it is not entirely without risk. Companies that sell receivables receive cash more quickly than expected in the terms of their supplier deals via bank financing. This has the effect of pulling in some cash flow sooner than expected, which presents well to investors who are generally happy to see boosted cash flows from operations.

A change in the arrangement, however, or a counterparty issue with the bank being used, can create a nasty surprise for investors. Even worse, companies can often utilize receivable sales agreements as a way to generate leverage in ways that can go very, very wrong (see exhibit A here).

While we do not believe that Leggett is taking on leverage in its supplier financing arrangements, the volume of financing being transacted is something that investors should be aware of.

The company outlines the program on page 7 of its first quarter filing.

We participate in trade receivables sales programs in combination with certain customers and third-party banking institutions. Under each of these programs, we sell our entire interest in the trade receivable for 100% of face value, less a discount. Because control of the sold receivable is transferred to the buyer at the time of sale, accounts receivable balances sold are removed from the Consolidated Condensed Balance Sheets and the related proceeds are reported as cash provided by operating activities in the Consolidated Condensed Statements of Cash Flows. We had approximately $50.0 and $55.0 of trade receivables that were sold and removed from our Consolidated Condensed Balance Sheets at March 31, 2023 and December 31, 2022, respectively.

In other words, the company had $50 million removed in advance of the expected payment terms from its balance sheet and added to cash from operations. Reviewing the statement of cash flows won't reveal a clean $50 million line item--the company has consolidated it with other activities making its identification quite difficult.

However, it doesn't take a math genius to see that if the bank in question were to reduce or eliminate the program with Leggett in a quest to reduce its own overall leverage (due to deposit flight or other underlying credit concerns) that a substantial portion of Leggett's cash flows could be impacted. It is not a far leap of logic to see how this could impact the dividend, or the board's willingness to raise it.

The Bottom Line

Leggett & Platt is an old-school manufacturer in an old-school business. While it has an attractive dividend, macroeconomic pressures as well as internal financing programs give us caution. Risks to our thesis include an unexpected reduction in steel costs, which would improve margin profile and cash flow. However, today we remain on the sidelines for this company.