Is Leggett & Platt a growth trap? (Part 1 of 2)

Value Investing Case Study 15-1. I first covered Leggett & Platt in Feb 2021 in Seeking Alpha. At that juncture, the company had yet to release its 2020 results. This post is an updated analysis incorporating the 2020 financials.
 
Is Leggett & Platt a growth trap?

Leggett & Platt (LEG or the Group) is an S&P 500 diversified manufacturer that is trading at USD 54.65 per share as of 7 June 2021. In my Seeking Alpha article, I had estimated LEG intrinsic value to be USD 50 per share.

The current market price has overshot my estimated intrinsic value. 

LEG Book Value as of 31 Mac 2021 was USD 10.70 per share resulting in a 5.1 Price to Book multiple.  At the same time, the Price to Earnings multiple based on the average 2010 to 2020 earnings was 29.3.

By convention, a stock with a high Price to Book and Price to Earnings multiples would be considered a growth stock. 

But for the year ended Dec 2020, the Group revenue was 10 % lower compared with the revenue for the same period last year while the net income was 26 % lower.

Is this a sign of a growth stock or is LEG a growth trap? A growth trap is a stock that appears to be priced as if it had a high growth rate. But, the growth rate is not sustainable.

Join me in a 2-part series where I will lay out my case on why LEG is not a growth stock. It is a growth trap at the current price.

Should you go and short it? Well, read my Disclaimer.

Contents

  • What is so unique about LEG?
  • Has it used its Funds in the Best Way?
  • Can you describe the Current Performance as Outstanding?
  • Is there a Rich and Unique History?
  • Is there a Great Future?
  • Pulling it all together

What is so unique about Leggett & Platt?

What is so unique about LEG?

LEG was founded in 1883 and is a pioneer in sleep technology with the introduction of its bedspring more than 135 years ago. Today the Group conceives, designs, and produces a diverse array of products that can be found in most homes, offices, and vehicles. 

The Group serves a broad suite of customers that comprise a "Who's Who" of U.S. companies through 140 facilities in 18 countries. 

LEG operations are organized into 3 segments:
  • Bedding products.  As "The Components People," LEG is the leading supplier of a wide range of products and components for the home. These include mattress springs and specialty foam, as well as adjustable beds, bedding machinery, steel rod, and drawn wire.
  • Furniture, flooring, and textile products.  LEG is a leading producer of components and engineered systems for office, residential, and contract furniture manufacturers. The products in this category include seat recliner mechanisms and controls, and furniture bases. 
  • Specialized products. LEG is the world's foremost designer and manufacturer of seating support and comfort systems in the automotive industry. Other products include titanium, nickel, and stainless steel tubing for the aerospace industry and hydraulic cylinders for the construction industry. 

The US accounted for about 2/3 of the Group’s revenue with the balance from Europe, China, Canada, and Mexico.  

Case Notes

These segments shown above are the reporting segments effective 1 Jan 2020. Prior to this, the Group was organized into 4 segments.

The new Bedding segment consists of:
  • The former Residential Products and Industrial Products segments.
  • The Consumer Products Group/Adjustable Bed units.

It excluded the Fabric and Flooring Products Group which has been transferred to the new Furniture, Flooring, and Textile segment.

The new Furniture, Flooring and Textile segment consists of:
  • The former Furniture Products segment.
  • The Fabric and Flooring Products Group.

It excluded the Consumer Products Group which has been transferred to the new Bedding segment.

There is no change in the composition of the Specialty segment. 

To ensure consistency, I have tried to re-allocate the historical segment info in line with the new segment organization.




Has it used its Funds in the Best Way?

As of the end of Mac 2021, LEG had a Total Capital Employed (TCE) of USD 3.62 billion. 

Shareholder’s fund accounted for 40 % of the TCE with almost all the balance from debt. Note that in this context, debt includes both operating and finance lease liabilities.

LEG Sources and Uses of funds
Table 1: Sources and Uses of Funds

LEG's capital structure is equal to a book debt to TCE ratio of 60 %.  Compare this to the US Furniture/Home Furnishing sector average of 47 % (Source: Damodaran Jan 2021).  

LEG Capital Structure and deployment of funds
Chart 1: Capital structure and deployment of funds

If you translate this into a book Debt to Equity ratio, LEG would have a Debt to Equity of 1.5 compared to the industry average of 0.9.  LEG is higher geared.  

But, this high gearing is only a recent situation as, before the acquisition of Elite Comfort Solutions Inc (ECS) in 2019, the Debt-Equity ratio was below 1.0 as can be seen from the chart below.

LEG DE ratio
Chart 2: Debt Equity ratio

The Group did not provide any breakdown of how its funds have been deployed by segments or regions. 

However, based on the total tangible assets you can see that the bulk has been deployed to the US.

LEG Assets by regions
Chart 3: Assets by regions

Can you describe the Current Performance as Outstanding?

For the year ended Dec 2020, the Group achieved USD 4.3 billion of revenue with USD 248 million net income.

In comparison with the same period last year, the current period revenue is 10 % lower while the net income is 26 % lower.

The decrease in revenue was due mainly to the Covid-19 related demand decline. The net income was lower due to lower sales volume as well as goodwill impairment charges partially offset by fixed cost reductions. 

For the first quarter ended March 2021, the Group achieved USD 1.15 billion of revenue compared to USD 1.05 billion for the same period last year. This is about 10 % growth. The net income for the first quarter was USD 88 million which is about doubled that of the same period last year.

Management has attributed the first-quarter earnings to: 

“…primarily from volume growth, lower fixed costs, and the non-recurrence of USD 8 million impairment charge…and a USD 4 million write-off of stock associated with a prior year divesture.”

Due to the Covid-19 pandemic, I would be wary of comparing the current period's performance with that of last year. Instead, I would focus on the long-term picture. 

The 2020 revenue decline is in contrast with the long-term growth in revenue as can be seen from the Performance Index chart below. 
  • There was a jump in revenue between 2018 and 2019 due to the acquisition of ECS which contributed to a 13 % increase.  But this was partly reduced by the closure of the Fashion Bed business and the restructuring of the Home Furniture business.
  • The Group revenue grew at a CAGR of 2.5 % from 2010 to 2020.

Gross profitability which had some improvement from 2014 to 2016 has declined since then. Part of the decline is due to the acquisition of ECS.  ECS has a lower gross profit margin at 19 % (in 2018) compared to the rest of LEG which averaged 25 %. 

LEG Performance Index
Chart 4: Performance Index

Net income showed a long-term uptrend although it dipped in 2013 and 2014 due to the following: 
  • The results in 2013 were due to a USD 63 million impairment. This was for goodwill and intangibles for assets related to the Commercial Vehicle Products.
  • In 2014, there was a loss of USD 124 million following the sale and discontinuation of the Store Fixtures unit.

An analysis of the performance of the 3 LEG segments showed:
  • The Bedding segment is the largest revenue and EBIT contributor.
  • The best return comes from the Specialty Products segment.
LEG Segment performance
Table 2: Segment performance
Notes
a) Due to the new re-organization, the average revenue and EBIT were only available for the past 3 years ie 2018 to 2020. 
b) LEG did not provide a breakdown of TCE by segment. The Total Assets for each segment were derived assuming that the current liabilities included in the segment assets were apportioned based on the value of the respective segment assets. The majority of the assets under Corporate are due to intangibles. 
c) Return = 3 yr ave EBIT / Total Assets

Is there a Rich and Unique History?

The company was started in 1883 when J.P. Leggett developed the idea for a spiral steel coil bedspring.  He then went to his future brother-in-law, C.B. Platt, for his manufacturing capability and expertise. Together they produced the L&P bedspring, patented in 1885.

LEG is today an industrial group as its products are sold to other industries rather than to consumers.  Even though it pioneered the spring mattress, the LEG Bedding segment focuses on supplying a variety of components and machinery used by bedding manufacturers.  LEG also produces private-label finished mattresses for bedding brands and retailers. 

LEG's business model appears to be one where there is annual closure or sale of business units as well as new acquisitions. The revenue growth is the net effect of these acquisitions and business closure. From 2010 to 2020:
  • 13 business units were discontinued or sold.
  • There were 29 (including ECS) acquisitions. Except for ECS, all these were within the existing Classic LEG businesses and/or products. 
  • At USD 1.2 billion ECS was the biggest acquisition over the past decade. Excluding ECS, LEG only spent USD 0.5 billion over the past 10 years for the other 28 acquisitions. 

The acquisition of ECS opened up a potentially new growth path for LEG.  As such, I would like to analyze the business based on considering LEG as a USD 4.8 billion Total Assets group comprising 2 divisions.
  • The Specialty Foam division employing about USD 1.3 billion of total assets.
  • The rest of the LEG business units (Classic LEG division) employing about USD 3.5 billion of total assets.

About 46 % of LEG 2020 Total Assets comprises goodwill and intangibles.  The breakdown of the Total Assets into the Specialty Foam and Classic LEG divisions are shown in the chart below.

LEG total assets profile by segment
Chart 5: Segment Total Assets profile 

You will note that a very significant part of the Specialty Foam division’s Total Assets comprises goodwill and intangibles.

At the same time, to have a long-term outlook of the business, I will focus on the pre-Covid historical performance. 

Classic LEG division

Excluding the Specialty Foam division, I estimated that the Classic LEG division generated revenue of USD 4.1 billion in 2019.  Over the period from 2010 to 2019, the Classic LEG division revenue grew at 2.2 % CAGR.  

The Classic LEG division is organized into 3 segments as of Jan 2020.  The chart below shows how the 3 segments have performed over the past 10 years. 
  • The Bedding segment accounted for 39 % of the 2019 group revenue. But it only achieved 0.5 % CAGR in revenue between 2010 and 2019.
  • Furniture, Flooring & Textile is the next biggest revenue contributor. It achieved a 1.3 % CAGR. 
  • The Speciality segment accounted for about 26 % of the 2019 group revenue. However, this is the fastest-growing segment with a 7.4 % CAGR in revenue. This is despite the complete closure of the Commercial Vehicle Business in 2017.  In the first half of the decade, the Commercial Vehicle Business contributed about USD 120 million annual revenue.

You can see that the Classic LEG division is a “steady” business. 

LEG Classic segment revenue
Chart 6: Classic LEG segment revenue profile
Note: The 2010 to 2016 segment figures were estimated based on the business unit’s revenue. It may not be the same as those if they were recast by LEG.  However, it should provide a picture of the trend over the years.

Specialty Foam division

In Jan 2019, LEG acquired ECS for USD 1.24 billion.  This became the Specialty Foam business unit under the LEG organization structure.  

ECS is a leader in the proprietary specialized foam technology for the bedding and furniture industries. Its products included:
  • Finished mattresses sold through both traditional and online channels.
  • Mattress components, mattress toppers, pillows, and furniture foam.

About 65 % of ECS sales were to the bedding sector with 25 % to the furniture sector. Given LEG's bedding business, you can see the logic for the acquisition.

LEG - ECS Sales profile
Chart 7: ECS sales profile   Source: LEG Nov 2018 Investors Presentation

What is the Specialty Foam division's potential contribution to LEG? I estimated this based on the information provided by LEG in its SEC Filings and summarized it as below.

LEG Specialty Foam potential
Table 3: Speciality Foam potential
Notes
(a) Source: LEG SEC Filing on ECS Performa financial statements. 

I estimated that the Specialty Foam division would be able to provide double-digit growth to LEG.
  • In its Nov 2018 presentation to investors, LEG represented that ECS is expected to generate double digits revenue growth.  
  • Then in its 2019 Highlights of its SEC Filings, LEG reported that ECS added 14 % to its 2019 revenue.  This is equal to about USD 665 million. Considering that the acquisition of ECS was in Jan 2019, I estimated that full-year Specialty Foam division revenue to be USD 725 million.  This is about 19 % growth compared to the 2018 Performa revenue. 

Given ECS 2018 gross profit margin and SGA, the USD 725 million revenue works out to be about USD 79 million EBIT. This is equal to about 17 % of LEG group 2015 to 2019 average annual EBIT of USD 471 million. 

This 17 % EBIT contribution was generated from 27 % (USD 1.3 billion) of the Group's Total Assets in 2020.  I hoped this gave you a sense of the contribution of the Specialty Foam division from an enterprise perspective.  

Is there a Great Future?

The businesses within the 3 segments of the Classic LEG division are in established industries.  While not growth industries, they are not sunset ones either.

The US bedding (mattresses and foundations) market grew at a CAGR of 5.6 % from 1997 to 2017.  The forward growth projections are below the long-term US GDP growth rate of 4 %.  The non-US market is projected to grow at a slightly higher rate than that of the US. I have a comprehensive write-up on this sector in my Tempur-Sealy post that you can refer to. 

For the Furniture, Flooring and Textile segment, we have the following:
  • According to Statista, revenue in the US furniture market amounted to US$249 billion in 2021. The market is expected to grow annually by 2.17% (CAGR 2021-2025). On a global basis, most of the revenue is generated in the United States.
  • According to Grand View Research, the global flooring market size was valued at USD 388.24 billion in 2020.  It is expected to grow at a compound annual growth rate (CAGR) of 6.1% from 2021 to 2028.
  • In the Specialty products segment, the Automotive group accounted for about ¾ of the segment revenue. Statista projected the global automotive industry revenue to grow from USD 5,315 billion in 2017 to USD 8,931 billion in 2030. This is equal to a CAGR of 4.1 %

It would appear that any significant growth for LEG would have to be from the Specialty Foam division

Specialty Foam division

According to its website, ECS is a premier leader in foam technology for several industries. These included the bedding, furniture, automotive, medical, and packaging industries.

The main component of foam is polyurethane. This is a common and versatile plastic polymer that can be used to produce a wide range of materials and products. By adding various compounds and additives to polyurethane you affect two of the main qualities of foam - viscosity and elasticity. 

Different manufacturers have different “recipes” for the chemicals they add to the foam and the processes they use to create the foam. These recipes and processes affect the feel and function of each individual product. And they are often proprietary secrets.

LEG has focussed on ECS's contribution to its bedding business in announcing the acquisition. However, I believe that the Specialty Foam division opens up a new growth possibility for LEG ie into the polyfoam market. 

According to Grand View Research, the global polymer foam market size was valued at USD 113.89 billion in 2019. This is projected to expand at a CAGR of 3.8% from 2020 to 2027. Growing applications in various industries are expected to drive demand.

“The global polyurethane foams market is projected to grow…at a CAGR of 7.5% from 2020 to 2025. Increased use of polyurethane foams in building insulations for energy conservation and versatility and unique physical properties of polyurethane foams are driving factors for growth.” Market and Market

I believe that the Specialty Foam division can benefit the Classic LEG business units beyond the bedding business. 
  • LEG is already serving some non-bedding markets eg furniture, automotive, construction, and would be able to tap into these.
  • In the foam business, the key is the “formula” and the proprietary and patented technology will be a differentiator. 

As can be seen from the chart below, the furniture and bedding sector is a relatively small segment of the US polymer foam market.  The Specialty Foam division provides LEG with a potential growth path.

LEG US Foam industry
Chart 8: US Polyfoam industry   Source: Grand View Research

Pulling it all together

By analyzing LEG as comprising a Special Foam division and a Classic LEG division, you can see the growth potential for LEG.
  • The Classic LEG division is a “steady” business with revenue growing at a CAGR of 2.2 % from 2010 to 2019.
  • The Specialty Foam division is in a growth sector with double-digit revenue growth in 2019.

LEG management has extolled the Specialty Foam contribution to LEG's bedding business. I believe that there are synergies with the other business units in the Group. This is considering that foam is used in the furniture, flooring, construction, and automotive sectors.

The Specialty Foam division employed about 27 % of LEG Total Assets. Thus, any contribution will have a significant impact on the Group's performance. 

The question is whether it will be able to transform the Group into a growth stock. For this to happen, the following must occur:
  • The Specialty Foam division growth must result in double-digit growth for the Group.
  • The intrinsic value of the Group must far exceed the current market price.

The revenue growth for the Group in the first quarter of 2021 barely touched 10%. The Group has not reported whether this growth was driven by the Speciality Foam division. At the same time, there is no conclusive evidence that the Group can sustain an overall growth rate of more than 10 % for several years.  

These are not signs of a growth stock. Is LEG a growth trap then?

But for a definitive answer on whether LEG is a growth trap, we will have to consider its intrinsic value. 

Join me in Part 2 of this series as I cover the valuation and risks of LEG.


End of Part 1 of 2

Part 2 of 2 was be published on 27 Jun 2021




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