Markets & Finance

A Comfortable Investment


By Efraim Levy With its excellent growth prospects, strong cash flow, and healthy balance sheet -- plus steadily rising cash dividends as a kicker -- Leggett & Platt (LEG) merits S&P's highest investment ranking of 5 STARS, or strong buy. Leggett makes of a broad line of bedding and furniture components, and other home, office, and commercial furnishings, as well as diversified products for nonfurnishing markets.

Although the demand for furniture and related products is highly cyclical, we at S&P believe that Leggett's diverse customer base insulates it reasonably well from fluctuations in retail demand. And we believe that the company's proprietary manufacturing technology and machinery give it a competitive edge.

In 2001, Leggett's revenues declined for only the second time in its 34 years as a public company. Still, cash flow -- net income plus depreciation, depletion, and amortization -- rose for the 14th consecutive year, reaching $535 million, a 21% advance from 2000's record level.

PLENTY OF PICKINGS. What has fueled Leggett's impressive long-term results? A combination of internal growth and acquisitions. Over the past four years, it has bought more than 100 companies with a total of $1.76 billion in revenues.

And S&P sees this trend continuing well into the future despite the temporary softness in many pockets of Leggett's market. The furniture industry is still highly fragmented, so Leggett should have little trouble finding appropriate acquisition candidates at reasonable prices. In 2002, we expect the company to garner $100 million in revenues from new acquisitions, building on the approximately $75 million gained that way last year. Acquisitions, and a strengthening U.S. economy, should help Leggett resume its double-digit sales growth.

The company should be able to bolster its margins, a payoff from restructuring efforts and improved demand. Leggett should also benefit as it's able to leverage a larger sales base against fixed corporate costs. We're also encouraged by the company's healthy cash flow. Depreciation should exceed capital expenditures in 2002 and 2003, as the company limits most of its investments to maintenance costs.

HITTING TARGETS. With improving same-store-sales comparisons, reduced overhead costs, and greater operating efficiencies from improved capacity utilization at its facilities, we see 2002 earnings per share for Leggett rising to $1.24, including a $0.10 benefit from changes in goodwill accounting, from $0.94 in 2001.

And the growth should continue in 2003. We see acquisitions, higher comparable-store growth, and improving operating margins lifting earnings per share to $1.55. We also believe that Leggett can continue to meet its long-term targeted annual earnings growth rates, in the mid-teens.

Given the company's consistent historical performance, excellent growth prospects, and an improving economy, we feel that Leggett's shares are undervalued at approximately 15 times our 2003 earnings per share estimate. The shares trade at a sizable discount to the broader market, and S&P's proprietary discounted cash flow analysis also implies that the shares are undervalued.

FAVORABLE COMPARISON. Based on our assumption of low-teen growth in annual free cash flow over the next 10 years, before declining to eventually level off at 3.5%, we believe that the shares trade at a significant discount to their fair value of more than $40.

Considering the consistency of Leggett's past earnings growth, an estimated price-earnings-to-growth (PEG) ratio of 1.3, or approximately 19 times our estimated 2003 earnings per share, appears reasonable to us. This compares favorably to the PEG ratio of 1.8, or 21 times estimated 2003 earnings, for the S&P 500. In using what we believe are fairly conservative assumptions, our 12-month target price for Leggett is $29, which implies possible significant upside potential. And with a secure dividend yielding 2%, the shares offer above-average total-return potential. Levy is an equity analyst for Standard & Poor's


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