This challenging environment has endured longer than many expected, as noted by the firm's CEO, Mitch Dolloff, on a call with analysts earlier today:
I feel like that there is some optimism as we went into the year that residential end markets would start to recover in the middle of the year, and they really didn't. And then there was some optimism that we'd see stronger home furniture sales in the fourth quarter, and we really didn't.
And so I think that there's a little bit of, I'd just say, concern about being too optimistic until we start to really see some changes in demand. So that's why we're trying to manage the current environment, we know volume will come back, hopefully sooner rather than later, but it's hard to predict.
Reflecting these lingering headwinds, Leggett & Platt on Monday tempered its EPS guidance for the year by around 10%, pushing the expected earnings payout ratio to about 130%.
However, while earnings will fall short of the payout this year, the firm's free cash flow is still 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.
Even so, these stubborn demand headwinds could persist for longer than anticipated without any major catalyst on the horizon to spur consumer demand. Interest rates are expected to remain higher for longer, inflated prices are unlikely to retreat, and consumer confidence is fading over concerns of recession and political turmoil around the world.
Since our scores assess dividend risk over a full economic cycle and the firm's financial health has weakened further, narrowing the margin of safety for the payout, we are lowering Leggett & Platt's Dividend Safety Score from 60 to 50 within our Borderline Safe bucket.
If we see improvement in the company's payout ratio and leverage, providing a bigger cushion to weather a deeper downturn, or see clearer signs that consumer demand won't take another leg down from here, we would anticipate upgrading Leggett's score.
For now, the Dividend King remains committed to its dividend, and most of the issues weighing on Leggett & Platt appear transitory and unrelated to the company's long-term outlook.
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 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.