Economic Challenges Unlikely to Disrupt Leggett & Platt's Dividend

Leggett & Platt is now trading with one of the highest yields offered by a Dividend King at over 4.5%, as fragile economic conditions have weighed on the company's stock.

Stubbornly high inflation and continued supply chain disruptions have led to lower sales volumes for the manufacturer of engineered components such as mattress springs and foams, recliner mechanisms, adjustable beds, steel wire, seat frames, carpet cushioning, and armrests.  

However, Leggett & Platt has successfully passed inflated costs on to customers, resulting in modest earnings growth. This profit stability has been a testament to the firm's strong market positioning, where it boasts a No. 1 or No. 2 market share in most of its operating categories.

While economic outlooks continue to sour, Leggett & Platt is entering a period of potentially increased instability better positioned than when the pandemic began, with an improved balance sheet and an upgraded S&P credit rating of BBB.

With a looming recession threat, it's worth noting that when weekly sales dropped a staggering 60% in the pits of the pandemic, Leggett & Platt remained firmly committed to the dividend and has since raised the payout twice, extending the firm's long track record of growing the dividend annually for 51 consecutive years.

Although sales could be choppy until the economy stabilizes, supplying essential parts and being one of the lower-cost component providers for bedding, furniture, cars, and other durable goods should continue to provide Leggett & Platt with enough pricing power to support earnings.

Furthermore, many of the firm's operating costs are variable, so expenses contract when volumes decline, helping the company sustain profit margins over a full economic cycle.

We expect the company to remain dedicated to dividend growth even through the challenges of a potential recession, backed by the firm's healthy balance sheet and strong customer relationships. As such, we are reaffirming Leggett & Platt's Safe Dividend Safety Score.

Despite our confidence in the company's dividend safety, some investors have expressed concern over the failure of free cash flow to cover the dividend last year for the first time in at least a decade. While this can sometimes point to an issue that could eventually lead to a reduced payout, we don't believe that's the case here. 

Last year, Leggett & Platt spent over $300 million rebuilding a depleted inventory from pandemic effects compared to the company's $240 million annual dividend. But this was an abnormal event, and inventory levels and free cash flow are expected to normalize and should produce a payout fully covered by free cash flow.

It's also worth noting that Leggett & Platt's free cash flow typically increases during recessions, as inventory levels are drawn down, accounts receivable are collected faster than new sales are made, and capital spending can be flexed lower. 

This helps the company emerge strongly from downturns as it pursues its long-term revenue growth target of 6% to 9%, fueled by efforts to increase content with existing customers, expand its addressable markets (e.g. specialty foam for mattresses), and make bolt-on acquisitions of complementary products and growth platforms (e.g. aerospace).

Overall, while it may take a few years for the share price to return to 2021 highs, for conservative income investors who believe in the company's long-term outlook, Leggett & Platt's attractive 4.5%-plus yield and Safe Dividend Safety Score may be worth a closer look.

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