For nearly a decade, we have been successfully executing a strategy that has enabled the company to generate strong Total Shareholder Return, or TSR1, while significantly improving operational performance. We remain committed to our longstanding goal of achieving TSR that ranks in the top third of the S&P 500 over rolling 3-year periods. In order to ensure that we continue achieving this goal, we revised our TSR framework in September 2016 to place a moderately higher emphasis on disciplined growth and a lesser requirement on further profit margin expansion. Those changes are discussed in more detail below.
Operationally, 2016 was another year of strong earnings and profit margins despite demand softness in many of our major markets. For the 45th consecutive year, we increased the dividend and did so at the highest growth rate since 2007. With significant earnings improvement over the past two years, our dividend is now within our targeted payout range, which should enable future dividend growth to more closely align with earnings growth.
The stock set a new record high in 2016, trading above $54 in July, and we once again achieved top third 3-year TSR.
Our primary financial goal, adopted in 2007, is to achieve TSR that ranks in the top third of the S&P 500 over rolling 3-year periods. We have achieved our goal in four of the seven 3-year periods since 2007 and been quite close in two other periods. Cumulatively, over the last nine years we generated TSR of 18% per year, which ranked in the top 9% of the S&P 500. For the 3 years that ended on December 31, 2016, we generated TSR of 20% per year on average, placing us in the top 11% of the S&P 500.
Early last year, we began to reevaluate our TSR framework and from that review process concluded that a few modifications were appropriate. In short, we moderately increased the expected long-term contribution from revenue growth (to 6-9% per year on average) and reduced the expected benefit from additional EBIT margin increases. Over the past three years, revenue growth from the combination of increased unit volume and acquisitions has approximated 7%2. Thus, our new growth target is closely aligned with recent performance and reflects our commitment to sustain growth at that level. In contrast, with our adjusted3 EBIT margin expanding by nearly 300 basis points in just the past two years (and now exceeding 13%), future margin increases will likely be smaller and generate less TSR benefit.
The table below shows the components for our TSR framework – our prior targets, actual performance, and the revised targets going forward. We believe that this level of performance will enable us to consistently achieve our top-third TSR goal.
Strategy and Growth
When we changed our strategic direction nearly a decade ago, we outlined three priorities: 1) Focus the portfolio by divesting low-performing businesses; 2) Improve margins and returns in the businesses we keep; and 3) Grow revenue long-term. Since then, we have narrowed our portfolio from 28 business units to 17 and increased adjusted3 EBIT margin by over 400 basis points. In essence, we have successfully executed the Focus and Improve priorities – and we’re now turning more attention to Growth.
For quite some time we have envisioned profitable revenue growth as the primary driver of our TSR, and as mentioned earlier, our long-term target is now 6-9%. We expect growth to come primarily from organic sources – opportunities we have developed within our Grow business units (such as Automotive, Bedding, Adjustable Bed, Work Furniture, Home Furniture, Geo Components, and Aerospace) along with market growth – and be augmented by carefully screened, strategic acquisitions that meet our established criteria.
Recent growth sources should continue for at least the next several years: the combination of market growth, content gains, and small bolt-on acquisitions should enable us to achieve our growth target. To ensure longer-term success, we are making internal structural changes that should improve the quality and quantity of profitable growth initiatives that we generate. First, we are implementing a formal Growth Identification Process within our business units to improve their ability to identify, appropriately resource, and bring to fruition profitable growth opportunities in our current markets. In addition, we are adding a small corporate team that will seek out new markets we could enter that strongly align with our Styles of Competition and core competencies.
Margins have improved significantly in recent years, are currently near record levels, and have contributed quite meaningfully to TSR. While our focus on portfolio optimization, continuous improvement, and operating efficiency will not change, future margin increases will contribute less to TSR.
Our long-held capital discipline, priority on balance sheet strength, and commitment to dividend growth also will not change. We recognize the importance of each of these factors to our long-term success, and we maintain an unwavering commitment to preserving these critical elements of Leggett’s financial strategy.
2016 was another year of strong earnings and margin improvement, despite softer-than-expected demand in many of our major markets. Sales decreased 4%, to $3.75 billion, with 2% unit volume growth and a slight increase from acquisitions, more than offset by divestitures (-4%), and raw material-related price decreases and currency impact (-3%). Growth in our Automotive business continued to be strong. We are significantly outperforming the global automotive industry with new program awards and added content. However, other businesses (including Bedding and Home Furniture) experienced soft market demand throughout the year.
EBIT margin grew to 13.9% in 2016; adjusted3 EBIT margin expanded to 13.1%, up slightly versus 2015 and at our highest level since 1999. We posted record 2016 EPS from continuing operations of $2.62, and record adjusted3 EPS from continuing operations of $2.49, a 6% increase versus 2015. This improvement primarily reflects a lower tax rate and reduced share count. The benefit from increased unit volume was more than offset by steel inflation and the non-recurrence of a pricing lag benefit associated with deflation late in 2015.
Dividends and Share Repurchases
2016 marked our 45th consecutive annual dividend increase, a record very few S&P 500 companies have achieved. In May, we increased the quarterly dividend by $.02, or 6%, to $.34 per share, our largest quarterly increase since 2007. Dividends generated a 3.2% yield for investors during 2016, one of the highest yields among the companies that comprise the S&P 500 Dividend Aristocrats.
Our target range for dividend payout is 50-60% of adjusted3 continuing operations EPS. Actual payout had been above that range in recent years, but with strong earnings growth we are now within the targeted payout range. Accordingly, future dividend growth should approximate earnings growth.
During the year, we repurchased 4.5 million shares of our stock and issued 2.4 million shares, largely for employee benefit plans. Shares outstanding decreased by 1.6%.
Sources and Uses of Cash
We generated $553 million of cash from operations during 2016, including a $25 million after-tax benefit from a litigation settlement. In each year for over 25 years, operations have produced significantly more cash than needed to fund capital expenditures and dividends. Major uses of cash in 2016 included $124 million for capital projects, $177 million for dividend payments, $30 million for acquisitions, $35 million for the remaining minority interest in a joint venture, and $193 million (net) to repurchase our stock.
We maintained our strong balance sheet and ended 2016 with net debt to net capital3 at 34%, comfortably within our longstanding target range of 30-40%. We also ended the year with over $550 million available through our commercial paper program.
2019 Operating Targets
Last year we disclosed to investors specific 2019 operating targets that should enable us to achieve our top-third TSR goal for the next 3-year measurement period. These operating targets are: 1) revenue of $4.75 billion; 2) EBIT margin of 13.3%; 3) EPS of $3.25; and 4) a dividend of $1.70 per share. These targets assume a stable macro environment that yields moderate demand growth as well as continued content gains and new product awards. These targets also anticipate that organic growth will be augmented by strategic acquisitions and envision no significant inflation, deflation, currency fluctuation, tax policy change, or divestitures.
As always, accomplishment of these operating targets and the long-term success of the company depend on the hard work and dedication of our 21,000 employees. So to our employees, thank you for your continued outstanding efforts in 2016 and together let’s keep working toward these goals. To our customers, we greatly value your ongoing support and will continue working diligently to exceed your expectations. Finally, to our investors, please know that we deeply appreciate your confidence in and commitment to Leggett & Platt.
Karl G. Glassman
President and CEO
February 22, 2017
¹ TSR = (change in stock price + dividends)/beginning stock price; assumes dividends are reinvested.
² 7% growth from unit volume + acquisitions, offset 4% by divestitures, commodity deflation, and currency.
³ Please refer to Non-GAAP Reconciliations page.