Leggett & Platt continues to be plagued by stubborn macroeconomic headwinds that have reduced demand for higher-priced home furnishings like mattresses, couches, and flooring, which make up around 70% of the manufacturer's revenue.
Source: Leggett & Platt Investor Presentation, August 2023
After a pandemic-driven shopping spree, consumer spending on these big-ticket items has naturally slowed, as many of these products were purchased for use over many years before needing replacement.
Additionally, retailers' inventory challenges over the past year have led many businesses to delay restocking bulky items that can be expensive to keep in storage. Given the ongoing threats of a possible recession, this cautious approach may continue.
Fanning these headwinds are higher interest rates and above-normal inflation that continue to squeeze consumers, leading management and analysts to no longer expect volume improvement until at least next year.
These pressures have slowed the firm's efforts to reduce its leverage ratio, which sits at a decade high and exceeds S&P's downgrade threshold for Leggett & Platt's BBB credit rating. S&P has issued a negative outlook for the diversified components manufacturer.
Source: Simply Safe Dividends
With the company's leverage remaining higher for longer than we anticipated, we are downgrading Leggett & Platt's Dividend Safety Score from Safe to Borderline Safe until the firm's balance sheet improves – hopefully by this time next year.
We'd say we're near the peak of our leverage... [and expect leverage ratios] to begin to improve by the end of the year and continue to improve into 2024.
... we don't have a specific [leverage ratio] target right now, but we are committed to being a strong investment-grade company, which, in our view, from a long-term perspective means having net debt-to-EBITDA in the 2.5x and under range.
– CFO Ben Burns, 8/1/23 Earnings Call
While this downgraded Dividend Safety Score is a better reflection of the firm's ongoing challenges, the Dividend King remains committed to the payout and seems willing to maintain its track record despite its stretched finances.
Although earnings will fail to cover the payout this year, the firm's free cash flow is projected to cover both dividends and capital expenditures, as it has done in 33 of the last 34 years. This reflects Leggett & Platt's high mix of variable costs and ability to free up working capital when demand slows.
Source: Simply Safe Dividends
As such, shareholders who believe in the firm's long-term prospects may want to maintain their positions as we plan to do in our Conservative Retirees and Top 20 Stocks portfolios.
Leggett & Platt holds a leading market share in most of its categories, where the manufacturer's components, including mattress springs and foams, seat frames, recliner mechanisms, and armrests, are often critical parts for its customers' end products.
And the company's specialized products in the automotive, aerospace, and hydraulic cylinders markets (generating around 25% of sales) have experienced steady sales growth despite the softening economy – providing some cushion against the headwinds in residential end markets.
Even so, investors should understand that Leggett & Platt's stock price may be slow to recover if the firm's challenges persist longer than expected and the economy continues to flirt with recession.
We'll be keeping a close eye on Leggett & Platt, providing updates as needed.
