sefa ozel
Introduction
Leggett & Platt, Inc. (NYSE:LEG), the diversified manufacturer of consumer durables and industrial products, released its first quarter 2024 results yesterday and announced a drastic 89% dividend cut. I cover the company fairly regularly here on Seeking Alpha. In my last article in February, I provided an update on Leggett's operations, liquidity and balance sheet strength after the release of 2023 full-year earnings. Admittedly, I didn't see the dividend in immediate jeopardy due to the still manageable leverage and adequate liquidity, but also because management had de facto already guided for a modest dividend increase this year.
Leggett & Platt's management attaches great importance to the dividend, so the cut was definitely not taken lightly and indicates that the company's situation is grave. In this update, I will therefore share my view on the Leggett's operations in the first quarter of 2024 and explore whether the de facto elimination of the previously sacrosanct dividend could be a sign of an existential threat. Finally, I will explain how I have decided to proceed with my position in LEG stock.
Leggett & Platt Cut Its Dividend After 51 Years Of Increases – A Sign Of An Existential Threat?
For the first quarter of 2024, Leggett & Platt reported net sales of $1.1 billion, down 10% year-over-year - recall Leggett had already reported an 8% year-over-year decline in sales in the first quarter of 2023. Earnings per share (EPS) came in slightly below consensus at $0.23, down 41% year-over-year. However, management left full-year guidance unchanged and continues to expect sales of $4.5 billion and adjusted EPS of $1.05 - $1.35.
CEO Dolloff's comment in the earnings release that "first quarter results were in line with [...] expectations" came as a bit of a surprise in the context of the dividend cut. Let's remember that the company has guided for a dividend payout of approximately $245 million at the beginning of February, even hinting at a small increase. Apparently, something must have gone against expectations; otherwise, the company would not have cut the dividend by almost 90%.
Looking at Leggett's segments, it is clear that the Specialized Products segment is now also reporting negative sales growth. Volume stagnated as the continued growth in the Aerospace sub-segment compensated for the decline in Hydraulic Cylinder sub-segment volume. In Q4, both sub-segments were still growing, both in terms of volume and sales. Due to the small difference (the sequential difference in volume growth is 3 percentage points), I would not overstate the figure and suspect it is due to the timing of purchases from Leggett customers. In addition, the full-year guidance of low single digit volume growth has been maintained.
The Bedding Products segment continues to perform poorly - as expected - with sales down 15% year-over-year, mainly due to a 10% decline in volume, which is significantly worse than in the fourth quarter when volume was down 6%. The "good" news is that management still expects full-year volume decline to remain in the high single digits, as previously.
The Furniture, Flooring & Textiles segment recorded a 5% decline in volume (1 percentage point less than in the fourth quarter) and segment sales fell by 9% due to weaker raw material-related prices. As in the other segments, the volume guidance for the year as a whole (decline in the low single-digit range) was maintained.
Finally, Leggett's restructuring program is also progressing as expected and the company has not changed its guidance for costs incurred ($20-$25 million in H1) and expected EBIT benefit ($5-$10 million in H2) in 2024.
However, while the sales, volume and EPS guidance has been fully maintained, and the restructuring program is progressing as expected, cash flow guidance has been revised downwards.
The company now expects cash flow from operating activities to be around 10% lower, so maintaining capital expenditure at $110 million (midpoint) will result in free cash flow of only around $200 million. I attribute the decline in operating cash flow to working capital-related effects. I already pointed out in my previous article that Leggett will likely pay out all of its 2024 free cash flow in the form of dividends, and may even be required to tap its liquidity resources (Figure 1) to bridge the gap. So factoring in the lower operating cash flow expectation, liquidity would definitely weaken over the year.
Based on the dividends already paid in 2024 and considering the rebased dividend ($0.05 per quarter and share), Leggett now expects to pay out $135 million this year, about 45% less than previously expected. Of course, this does not have much impact on Leggett's ability to manage its upcoming debt maturities (see Figure 5 in my last article). In November 2024, $300m will come due, and as previously expected, the repayment will be funded via the commercial paper program.
Figure 1: Leggett & Platt, Inc. (LEG): Liquidity at quarter- or year-end (own work, based on company filings)
In my view, the dividend cut is not a sign of an existential threat. The freed-up cash flow will be used to repay some of the (expensive) commercial paper outstanding as a result of the repayment of the 2024 3.80% notes. In 2025, assuming Leggett maintains the current quarterly dividend of $0.05 per share, it will only pay out about $28 million to shareholders. So even if free cash flow in 2025 is negatively impacted, Leggett's interest expense should remain manageable due to the proactive repayment of outstanding commercial paper.
The main reason for the dividend cut was already communicated at the end of March when the company announced the amendment of its credit agreement. As I pointed out in my September 2022 article, Leggett already agreed to more favorable terms (most notably the 3.5x leverage covenant based on net debt) in 2020 in the context of pandemic-related effects. Recently, this covenant was increased to 4.0x trailing 12-month adjusted EBITDA, but the change will revert to 3.5x on September 30, 2025. Due to the rather short time frame, but also the currently rather weak adjusted EBITDA and hence once again increased leverage (Figure 2), the focus on debt reduction is quite understandable.
Figure 2: Leggett & Platt, Inc. (LEG): Leverage in terms of net debt to trailing 12-months adjusted EBITDA (own work, based on company filings)
It should be noted, however, that management communicated the evaluation of capital allocation priorities back in March, "including the amount of cash allocated to [the] dividend program." To the best of my knowledge and after looking into the amendment agreement (dated March 22, 2024, found here), the decision to reduce the dividend was at management's discretion and not part of the agreement. This is quite reassuring, and although I am disappointed due to the poor communication (recall the guidance in early February), I appreciate management's emphasis on financial prudence.
Conclusion – And How I Decided To Proceed With My Position In LEG Stock
At first glance, and considering the guidance issued in early February, the dividend cut announced yesterday came as a nasty surprise. However, given the fact that management announced the amendment of the credit agreement by a temporary increase in the leverage covenant to 4.0x trailing 12-months adjusted EBITDA and at the same time reassessing capital allocation priorities - including the dividend - I expected a cut.
Therefore, the pre-market reaction of LEG shares of -15% at the time of writing is not entirely understandable. After all, Leggett's segments have performed as expected and management has reaffirmed its full-year sales, adjusted EPS and reported EPS guidance. The only metric that was revised down was operating cash flow guidance, which is now expected to be about 10% lower than in February, and I attribute this to working capital-related effects.
While there is of course nothing to gloss over about Leggett's current situation, which I have detailed in my previous articles, I see it as a positive that the dividend was not cut completely, which would have triggered additional selling pressure from dividend-focused funds. Finally, I think it's worth noting that the dividend cut was not part of the amendment agreement, so is clearly a sign of Leggett management's financial prudence and long-term focus. Nevertheless, the discrepancy between the early February guidance - when management was still hinting at a dividend increase (!) - and the almost 90% cut less than three months later is disappointing.
In my view, the fundamentals have not changed since my last article - Leggett is a cyclical company and is currently operating in a difficult demand environment, but there are no signs of an existential threat. I am therefore maintaining my position. Due to the cyclicality and therefore the current cheap (but on paper expensive) valuation, the focus on deleveraging and improving profitability, I maintain my "Buy" rating. Admittedly, I have built up my position in LEG stock too early so that I have already exhausted my hard position limit, which I have set at 1% of the total portfolio value in terms of invested capital. Therefore, I, personally, will not increase my position any further.
Thank you very much for reading my latest article. Whether you agree or disagree with my conclusions, I always welcome your opinion and feedback in the comments below. And if there's anything I should improve or expand on in future articles, drop me a line as well. As always, please consider this article only as a first step in your due diligence.
