I recently captured a sizable loss in 3M (MMM -0.76%) and was trying to find a high-yield industrial stock to buy in its place. I had long followed Leggett & Platt (LEG -0.73%). Given the similarities between the two companies, I ended up adding it to my portfolio despite the fact that it is facing material business headwinds today. Here's why.
A quick rundown of 3M
I bought 3M several years ago because it was a Dividend King that had fallen out of favor on Wall Street. Some of the positives for me were its diversified business and focus on innovation. What I didn't fully appreciate was the uncertainty of the legal issues 3M is facing (on both the product liability and environmental fronts), which I can't really track because management can't talk about legal matters. Although I believe it will muddle through these headwinds (I kept a small position so I will continue to monitor the progress), I wanted an investment that was facing less uncertainty.
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My choice was Leggett & Platt. From a top-level perspective, it has some important similarities to 3M. Notably, it has increased its dividend annually for 52 years and counting. While that's not quite as long as 3M's streak, it is pretty clear that Leggett & Platt places a very high priority on rewarding investors with reliable dividend growth.
To be fair, Leggett & Platt is a bit of a runt, given its $4.2 billion market cap (compared to 3M's $53 billion market cap). However, that's not exactly a negative. It takes less to grow a small company than it does a large one. So there's at least the potential for Leggett & Platt to make astute capital investments that will lead to an outsized effect on its business.
But one of the most important factors is really that Leggett & Platt lacks the legal and regulatory headwinds facing 3M. They are both cyclical stocks, but I don't have to worry that an adverse legal outcome will lead to billions of dollars in settlement costs. And that doesn't even consider the ongoing cost 3M faces as it defends itself. (Notably, Leggett & Platt's investor presentations contain an impressive amount of detail about its business, a refreshing change from 3M's need to keep mum about its legal headwinds.)
So what do I own?
Leggett & Platt has a diversified business, but roughly 42% is tied to bedding. That means that the performance of the housing market will have a big effect on the company's results, as a new bed often goes hand in hand with a new house. But it is worth noting that the company works with some of the biggest names in the bedding industry, like Tempur Sealy and Serta Simmons.
It has also been shifting with the bedding industry, adding foam-making technology to its more traditional spring bedding focus. So it also works with upstart brands like Purple and Casper. Beds aren't going away, so this business should be resilient over time even if it waxes and wanes with the economy.
Flooring and textiles make up 20% of the business. This sector is also economically sensitive and heavily tied to the housing market. To this, add another 7% of sales in the home furniture space and 5% from office furniture. While all tied together, these are different product categories that each offer growth opportunities.
Yet there are overlaps in technology. For example, the foam and springs that go into a bed are roughly similar to the foam and springs that go into furniture. And high-tech textiles are used in all three. That means that, like 3M, Leggett & Platt can take technology developed in one business unit and use it in another.
All that also helps with the 18% of sales from the auto sector, where Leggett & Platt makes things like seats. Although the vehicle space is very different from the housing sector (into which most of the company's products go), that just leads to a healthy dose of diversification despite the similarity of the products. And, notably, vehicle seats aren't likely to be affected by the shift toward electric vehicles.
The rest of the business is a little less connected, with 5% from hydraulic cylinders and 3% from aerospace. That said, these smaller divisions offer up interesting growth opportunities, particularly in the aerospace arena.
LEG Dividend Yield data by YCharts
So, from a business perspective, Leggett & Platt is fairly diversified with an opportunity to grow in a number of business lines that are supported by the ongoing demand in the bedding space. And yet you can't avoid the fact that the business, as a whole, is cyclical. The company is looking for sales to drop as much as 7% in 2023, with weakness in bedding, furniture, and flooring and textiles.
This isn't shocking -- and, given the company's Dividend King status, it has muddled through periods like this before. The company's more specialized products (aerospace, for example) are expected to see growth in 2023, hinting at the long-term desirability of being in these sectors.
Out of favor
The key factor here that got me to finally buy Leggett & Platt, a stock I've long followed, was the 5.8% dividend yield. That's toward the high end of the company's historical yield range. This suggests that, like 3M, Leggett & Platt is deeply out of favor right now and it is dramatically underperforming the market. Sure, there are good reasons for Wall Street's negative view of this cyclical stock, but at this point it looks like a deep value opportunity. Indeed, bad times have historically been followed by good times, economically speaking, and if that pattern holds, now could be a good time to buy out-of-favor Leggett & Platt for its rebound potential, which could lead to outsized gains from the currently depressed price point.
