- Leggett & Platt has increased its dividend for more than 40 consecutive years.
- But what does that tell us about the future dividend increases? Not much.
- Let's have a look at the Dividend Cushion to see if further increases are on the horizon.
History has revealed that the best-performing stocks during the previous decades have been those that shelled out ever-increasing cash to shareholders in the form of dividends. This makes a lot of sense, as the strongest dividend growers are often the strongest generators of increasing cash flow. Leggett & Platt (NYSE:LEG) is one such gem. Let's evaluate the firm's dividend growth prospects in this article.
But first, let's start with framing this analysis for readers. Most dividend assessments tend to be backward-looking -- meaning the evaluation rests more on what the company has done in the past: how long it has raised its dividend, for example. Don't misunderstand. We think analyzing historical trends is important, but investors should understand that for a cash-rich, growing company to raise its dividend by a reasonable amount in each of the past 20, 30 or more years isn't much to write home about.
Imagine, for example, giving your grandson $1 for his age on each consecutive birthday. Though you'll effectively be raising his "dividend" each year, the payout isn't necessarily tied to your income stream, nor is it very taxing on your lifestyle (even if he lives to 100 years or older). In a similar manner, a dividend payment is not explicitly tied to a firm's earnings stream nor is it very taxing on a firm to raise its dividend each year. For one, firms with substantial earnings don't have to pay a dividend, and companies can report declining earnings and still raise their dividend in the same earnings release.
Over the long haul, earnings growth will have to support dividend growth, but in instances where the payout ratio is low, earnings don't necessarily have to expand for the company to raise its dividend for years and years. A company can double its payout ratio by raising its dividend for 50 consecutive years, for example, but the payout ratio at the end of the period could still only be 50% of earnings at the beginning of the 50-year period. Fascinating, no?
With all of this said, it becomes obvious that assessing the future capacity of growth of the dividend is really what matters most for dividend growth investors. After all, dividend growth investors are investing for the next 5, 10, 20 years, not the past 5, 10, 20. And they want their dividends to increase by a material amount. This forward-looking perspective that assesses the potential magnitude of future dividend growth is all the difference in the world. That is why we created a forward-looking assessment of dividend growth through the innovative Valuentum Dividend Cushion methodology.
For those that may not be familiar with our boutique research firm, we generate a discounted cash-flow analysis for all firms in our coverage. We use these future forecasts of free cash flow (cash flow from operations less capital expenditures) and expected cash dividend payments and consider the company's net cash position to evaluate just how much capacity a firm has to keep raising its dividends long into the future.
The Dividend Cushion is a forward-looking ratio (with a numerator and a denominator). It tells investors how many times future free cash flow (cash from operations less capital spending) will cover future dividend payments after considering the net cash on the balance sheet, which is also a key source of dividend strength. It is purely fundamentally-based and driven from items taken directly off the financial statements.
Let's take a look at Leggett & Platt's investment highlights and then its dividend report to see how all of the analysis comes together.
Leggett & Platt's Investment Highlights
• Leggett & Platt's business quality (an evaluation of our ValueCreation™ and ValueRisk™ ratings) ranks among the best of the firms in our coverage universe. The firm has been generating economic value for shareholders with relatively stable operating results for the past few years, a combination we view very positively. We think it has an attractive Economic Castle rating. Learn more about the Economic Castle here.
• Leggett & Platt produces components and products found in many homes, offices, retail stores, automobiles and commercial aircraft. It is organized into four segments: Residential Furnishings, Commercial Fixturing, Industrial Materials, and Specialized Products. Steel is its largest input cost.
• Leggett & Platt has a good combination of strong free cash flow generation and manageable financial leverage. We expect the firm's free cash flow margin to average about 8.4% in coming years. Total debt-to-EBITDA was 2.3 last year, while debt-to-book capitalization stood at 42.4%. The US accounts for more than 70% of its business.
• Leggett & Platt is generally #1 or #2 in most of the markets that it serves, and the company competes with few large rivals. Furniture, bedding, and fabric/carpet are among its largest products. Revenue is expected to grow at a 4%-5% annual pace, and we like that management has skin in the game with incentives tied to ROCE.
• Leggett & Platt's management team is more financially-oriented than most, and we like this quite a bit. A look into their most recent presentations shows a focus on total shareholder return and other key shareholder metrics. We like the firm's transparency.
Leggett & Platt's Dividend Report
Leggett & Platt's dividend yield is nice, offering a ~3.5% annual payout at current price levels. The bottom right of the table below reveals our expectations for Leggett & Platt's future pace of dividend growth (~5% per annum). Please have a look.
Let's now dig into Leggett & Platt's qualitative ratings for dividend safety, dividend growth potential and risk of capital loss. The Dividend Cushion ratio not only informs our opinion of the safety of the dividend but also its capacity for future growth.
Dividend Safety / Cushion -- GOOD / 1.4
We assess the safety of a firm's dividend by adding the company's net balance sheet cash (total cash less total debt) to our forecast of its free cash flows (cash from operations less capital expenditures) over the next five years. We then divide that sum by the total expected cash dividends over the next five years. This process results in our Dividend Cushion™ ratio. A Dividend Cushion™ above 1 indicates a firm can cover its future dividends with net cash on hand and future free cash flow, while a score below 1 signals trouble may be on the horizon. By extension, the greater the score, the safer the dividend, as excess cash can be used to offset any unexpected earnings shortfall. Leggett & Platt scores a 1.4 on our Dividend Cushion™, which is GOOD. Remember -- the higher the score about 1, the better.
Dividend Growth Potential - GOOD
We judge the future potential growth of the dividend by evaluating the capacity for future increases, as measured by the Dividend Cushion ratio, and management's willingness to consistently raise the dividend, as measured by the firm's dividend track record. Leggett & Platt registers an GOOD rating on our scale, and we think the firm's annual dividend will be $1.46 per share within the next several years (by the end of fiscal 2018).
We assign the quantitative dividend growth rates to firms on the basis of their qualitative Dividend Growth rating. The scale we use as guidance to assign future dividend growth rates is shown below.
Dividend Growth Potential Scale
Excellent: 8% or higher
Very Poor: 0%-2%
In addition to assessing the Dividend Cushion ratio and the firm's dividend payment track record, we also evaluate recent growth rates in the dividend and/or the dividend payout ratio to fine-tune the trajectory of the future dividend forecasts, where necessary. For those interested in dividend growth forecasts for other companies, we have dividend growth forecasts for every company in our 1,000+ firm coverage universe that pays a meaningful dividend.
Risk of Capital Loss - MEDIUM
Though the dividend certainly can impact a company's share price, we assess the risk of capital loss within the valuation context. If the stock is undervalued (based on our DCF process), we think the risk of failing to recoup one's original capital investment (excluding dividends) is relatively LOW. If the stock is fairly valued (it falls within our fair value estimate range), we think the likelihood of losing capital (excluding dividends) is MEDIUM. If the stock is trading above our estimate of its intrinsic value, we think the likelihood of losing at least a portion of one's original investment (excluding dividends) is HIGH. Leggett & Platt registers a score of MEDIUM on our scale. Though we generally prefer firms that are underpriced, or have a LOW risk of capital loss, in this market environment, very few dividend growth firms are in this situation.
Wrapping It Up
We like Leggett & Platt's dividend growth potential. Though the firm's dividend doesn't make the cut for inclusion into the Dividend Growth portfolio (we can't hold every great dividend growth idea; only the best of the best), it still registers a strong Dividend Cushion score, especially for the size of its annual yield. Leggett & Platt is well-positioned to grow its dividend for many more years to come.
The following provides the definitions of the terms you may have read in the dividend report (image) above. Thank you for reading!