Published on February 6th, 2018 by Bob Ciura
When it comes to dividend growth stocks, the Dividend Aristocrats are the “cream of the crop”. The Dividend Aristocrats are a group of stocks in the S&P 500, which have raised their dividends for 25+ consecutive years. You can see all 53 Dividend Aristocrats here.
However, just because a stock has a place on the list of Dividend Aristocrats, does not automatically make it a buy at any price. Valuation is an important consideration before buying any stock. Focusing on buying Dividend Aristocrats when they are undervalued, can be a recipe for outstanding long-term returns.
For example, diversified manufacturer Leggett & Platt (LEG) is a high-quality company, with a strong industry position, and 40+ years of dividend increases.
On February 5th, the company released quarterly earnings results, and missed analyst expectations for both revenue and earnings-per-share. The stock declined 4% in after-hours trading as a result.
Leggett & Platt has a 3%+ dividend yield, and should continue to increase its dividend each year. In addition, the stock appears to be undervalued.
Leggett & Platt has been in business since 1883, when J.P. Leggett, an inventor, created a bedspring that was superior to the existing products at that time. Today, Leggett & Platt designs and manufactures a wide range of products, found in most homes and automobiles.
The company has 17 business units, 20,000 employees, and 130 manufacturing facilities across 19 countries. Leggett & Platt manufactures products including bedding components, bedding industry machinery, steel wire, adjustable beds, carpet cushioning, and vehicle seat support systems.
Source: Investor Presentation, page 4
For the fourth quarter, Leggett & Platt had earnings-per-share of $0.59, on revenue of $984 million. Revenue increased 9% from the same quarter a year ago, while earnings-per-share rose 11%. Both figures missed analyst expectations. Leggett & Platt was expected to generate earnings-per-share of $0.62, and revenue of $998 million.
Fourth quarter earnings include a $50 million charge, which equals $0.37 per share, for the estimated impact of the recently enacted tax reform law.
This is comprised of $0.49 per share tax charge related to repatriation of accumulated foreign earnings, a $.07 per share charge for accrual of foreign withholding taxes on expected future cash repatriations, and $.19 per share in tax benefits from revaluation of net future tax liabilities.
For the full year, sales grew 5%, to $3.94 billion. Comparable-location sales increased 6%, due to 4% volume growth, and 2% growth from price increases and currency impacts. Acquisitions also contributed 2% to sales growth, but were more than offset by divestitures.
Leggett & Platt generated strong sales growth, but full-year 2017 adjusted earnings-per-share from continuing operations decreased 1%, to $2.46. Sales growth was more than offset by higher steel costs. EBIT margin was 11.9% in 2017, compared with 13.9% in 2016.
Leggett & Platt has a multi-faceted growth strategy. First, the company seeks growth through targeted acquisitions of smaller competitors, in existing or new categories. In 2016, the company pursued mostly smaller, bolt-on acquisitions, totaling $30 million.
The businesses acquired included a U.S. manufacturer of aerospace tube assemblies, a distributor of geosynthetic products, and a South African producer of mattress inner-springs. The company also acquired the remaining interest in an automotive joint venture in China, for $35 million. More recently, Leggett & Platt said its acquisition of PHC will add 2% to sales growth.
Earnings growth is boosted by a strict focus on cost controls. It continuously evaluates its portfolio to ensure it is investing in the highest-growth opportunities. For low-growth or low-margin businesses, it either improves performance, or exits the category.
For 2018, Leggett expects sales growth and the benefit of share repurchases to outweigh the impact of rising raw materials costs. Earnings-per-share is expected in a range of $2.65 to $2.85, on sales of $4.2 billion to $4.3 billion. Earnings-per-share are likely to increase 6% to 9% in 2018.
Leggett & Platt will also benefit from tax reform. The company expects a lower 2018 effective tax rate, of approximately 22%. During 2018, the company expects to repatriate approximately $300 million of cash currently held in foreign accounts. The cash will be used for organic investments, dividends, acquisitions, share repurchases, and repaying $150 million of debt that matures in July 2018.
Valuation & Expected Returns
Based on 2017 results, Leggett & Platt stock trades for a price-to-earnings ratio of 17.7. In the past 10 years, the stock traded for an average price-to-earnings ratio of 19.8. This means the stock is trading significantly below its 10-year average.
Source: Value Line
Our estimate of fair value for Leggett & Platt, is a price-to-earnings ratio of 19 to 20. This is in-line with its historical valuation, which seems fair for a high-quality company with modest growth potential. As a result, fair value for Leggett & Platt is estimated at $46.74 to $49.20. This means the stock is currently undervalued by approximately 8% to 13%.
In addition, future returns will be generated from earnings growth and dividends. Based on growth trends in recent years, mid-to-high single digit earnings growth is a reasonable assumption. In that case, total returns would be as follows:
- 4%-6% revenue growth
- 1% share repurchases
- 3% dividend yield
In this forecast, total annual returns would reach 8%-10%, not including the impact of an expanding valuation multiple.
For example, if it takes three years for Leggett & Platt to reach our fair value estimate, it would add approximately 3% to 4% to annual returns. As a result, total expected returns would reach 11% to 14%, including earnings growth, dividends, and the impact of a rising price-to-earnings ratio.
Leggett & Platt stock has declined 10% since the beginning of 2018. The fourth-quarter earnings report missed analyst expectations, which is adding to the negative sentiment. But the company continues to grow sales at a strong pace.
Earnings were hit by rising steel costs, but long-term growth is likely, thanks to sales growth, share repurchases, cost cuts, and the effects of the recent tax reform.
With double-digit total return potential, a 3%+ dividend yield, and dividend increases each year, Leggett & Platt is an attractive stock for value and income investors.