An indirect investing approach is sometimes the preferred approach, especially when a sector under consideration is wobbling precariously. I thinks that's the case with the housing sector.
To be sure, the full-frontal (direct) investing approach -- Lennar (NYSE: LEN), Beazer (NYSE: BZH), KB Home (NYSE: KBH) or Toll Brothers (NYSE: TOL) -- would probably be the more lucrative approach over the long haul. But, in the short term, the immediate pain -- the prospect of more purchase cancellations, higher interest rates and ballooning foreclosures -- might be too much to bear.
Circling the Edges
I believe in the housing industry, but only agnostically-so in its current state. This is why I'm keen on circling the edges. One company I like on the periphery is Leggett & Platt (NYSE: LEG), a diversified manufacturer of engineered components for homes, offices, retail stores and automobiles. The company's largest segment, residential furnishings, accounts for 47% of sales and includes bedding, home furniture, and fabrics and fibers.
Unlike other companies exposed to housing, Leggett & Platt has been relatively immune to the sector's woes. It's actually thriving. For 2006, the company's profits rose 20% to $300.3 million ($1.61 a share), from $251.3 million ($1.30 a share) in the prior year. Meanwhile, sales grew 4% to $5.51 billion from $5.3 billion.
For 2007, Leggett & Platt expects EPS of $1.60 to $1.80 a share on sales of about $5.6 billion. This brackets Wall Street's estimate of $1.77 per share, but falls short of its original sales expectations of $5.72 billion. Of the expected 6% increase, 2% is expected to come organically while the remainder is expected to come from acquisitions.
Speaking of acquisitions, about two-thirds of Legg & Platt's revenue growth has come from acquisitions in the past 20 years. In the past decade, the average acquisition target had revenues of $15 million to $20 million, which the company believes minimizes the risk from any single acquisition. Today, no single customer accounts for more than 5% of total Leggett & Platt revenue.
Under Appreciated, Possibly Under Valued
With its strong cash flow (net operating cash flow increased to $169.9 million in the most recent quarter, a 15.4% increase compared to the last quarter), Leggett & Platt should be able to continue to pursue acquisitions, fund a continuing share buyback program, support its long-term goal of 15% annual EPS growth and continue to raise the dividend -- which has been increased at an 8% average annual rate for the past 10 years.
What's more, Leggett & Platt's ambitious plans should have negligible impact on financial risk. The current debt-to-equity ratio, 0.47, is low. It is below the industry average, implying successful management of debt levels. Along with this favorable debt-to-equity ratio, the company maintains an adequate quick ratio of 1.43, which illustrates an ability to avoid short-term liquidity problems.
My 12-month price target for Leggett & Platt's common is $29 a share. It is based on a simple net-present value calculation of an expected 2007 EPS of 1.70 that is expected to grow 3% annually for the next two years and 5% (far below the company's 15% goal) discounted using an 11% rate factor. My valuation is further supported by an average long-term P/E multiple of 17. (To learn more, read Target Prices Vs Ratings and Discounted Cash Flow Analysis.)
My valuation is based on housing's troubles persisting through 2007. Should housing improve this year, my valuation could prove overly conservative.
Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!