High-quality dividend growth stocks, including the Dividend Aristocrats , have obvious appeal. Income investors such as retirees who desire higher levels of investment income for their portfolios should consider the list of Dividend Aristocrats. The Dividend Aristocrats represent the cream of the crop of dividend growth stocks, as they have increased their dividends for at least 25 consecutive years or longer.
Leggett & Platt (LEG) is a Dividend Aristocrat that has increased its dividend each year for the past 47 years. With nearly five decades of steadily rising dividends under its belt, Leggett & Platt has proven that it has an established business model with competitive advantages. It is a growing business with a leadership position in its industry, which means it should have little trouble continuing to raise its dividend each year going forward.
Manufacturing Profits and Dividends for Shareholders
Leggett & Platt is a diversified manufacturing company. Its history goes all the way back to 1883, when it was founded by an inventor named J.P. Leggett, who created a bedspring that was superior to the existing products at that time. Today, Leggett & Platt designs and manufactures a wide range of products, including bedding components, bedding industry machinery, steel wire, adjustable beds, carpet cushioning, and vehicle seat support systems.
On Oct. 25 Leggett & Platt reported third-quarter sales of $1.09 billion, an increase of 8% from the same quarter last year. Excluding foreign exchange fluctuations, organic sales grew 6%, with volume up 3%. The company posted growth across several of its product segments, including Spring, Automotive, Adjustable Bed, Aerospace, Steel Rod and Work Furniture businesses. Another driver of sales growth was acquisitions conducted over the past year, which added 2% to Leggett & Platt's sales growth for the period.
Earnings per share came to $0.67, a 10% increase from the same quarter last year. Earnings growth came from a combination of revenue growth, as well as some margin expansion in the Steel Rod segment.
A highly profitable business model and strong earnings growth allow the company to return cash to shareholders. Leggett & Platt has a policy to distribute 50% to 60% of earnings each year as a dividend to shareholders. At that level, the dividend payout represents a compelling yield for shareholders at 4%, while providing the company the room to increase its dividend each year. The company should be able to continue growing its dividend each year, in line with its rate of earnings growth.
Growth Through a Major Acquisition
One potential risk factor for Leggett & Platt's near-term growth is cost inflation. Raw material costs are rising across a number of categories, as are transportation expenses. Rising costs could threaten margins going forward. Fortunately, Leggett & Platt maintains a strict focus on efficiency.
An example of this is the vertical integration in its steel business. Each year, Leggett & Platt melts over 550,000 tons of steel scrap at its Sterling, Illinois rod mill. It melts scrap into billets, which it then uses to make approximately 500,000 tons of steel rod each year. Approximately 70% of the steel rod is used to make Leggett & Platt products, while the unused portion is sold. This is just one example of how the company keeps costs low, which helps it generate strong cash flow each year and return cash to shareholders.
Because of this, Leggett & Platt has a positive growth outlook. As a diversified manufacturer, Leggett & Platt benefits from global economic growth. If the global economy stays out of recession, conditions would be broadly supportive of growth.
Leggett & Platt pursues future growth in part through acquisitions of smaller companies to enhance or broaden its product portfolio. For example, the company recently acquired Elite Comfort Solutions for $1.25 billion. The deal will significantly expand Leggett & Platt's exposure to specialty foam and other hybrid bed products. ECS had sales of $611 million in the most recent fiscal year.
The acquisition is expected to be neutral to Leggett & Platt's earnings per share in 2019, and be accretive to earnings starting in 2020. Leggett & Platt expects to deliver 6%-9% annual revenue growth over the long-term.
High Marks for Safety
Leggett & Platt ranks high in terms of safety, due to its strong balance sheet and sustainable dividend policy. The company has a trailing debt-to-adjusted-EBITDA ratio of 2.3x, indicative of a manageable level of debt. This is particularly important in times of rising interest rates, when highly indebted companies are burdened by higher costs of debt. Leggett & Platt is sufficiently protected from rising interest rates.
Adding to its safety are durable competitive advantages. The company has more than 125 manufacturing facilities worldwide, which provides it with global scale. Leggett & Platt also has an expansive intellectual property portfolio, consisting of 1,500 issued patents and nearly 1,000 registered trademarks. These competitive advantages insulate the company from the threat of losing market share to rival firms.
Valuation and Expected Returns Are Attractive
Leggett & Platt is a highly profitable company. At the midpoint of 2018 guidance, it is expected to generate EPS of $2.45. Based on this, the stock trades for a price-to- earnings ratio of 15.7, which is a low valuation multiple for a strong, growing company. Fair value for Leggett & Platt is significantly higher, at a price-to-earnings ratio of 18.0. As a result, the stock appears to be modestly undervalued right now. If the stock valuation expands to the fair value estimate, it would generate 2.8% annual returns for shareholders if mean reversion occurred over a five-year time period.
In addition, Leggett & Platt stock will provide returns to shareholders from earnings growth and dividends. Estimates call for the company to grow earnings by 6.0% over the next five years, and as previously mentioned the stock has a 4.0% dividend yield. As a result, the combination of valuation changes, earnings growth, and dividends leads to expected returns of 12.8% per year over the next five years.
This is an attractive expected rate of return for a blue-chip name with nearly 50 years of dividend increases.
(This article was originally sent Dec. 5 to subscribers of TheStreet's Income Seeker, a product presenting the world of opportunities in fixed income and dividend stocks. Click here to learn more about Income Seeker and to receive articles like this each day from Nick McCullum, Peter Tchir, Chris Versace and others.)
