2023-11-15 04:14:16 ET
Summary
- Stanley Black & Decker's quarterly earnings continued to show signs of weak demand, indicated by the lower sales volume. Consumer confidence again fell substantially, leaving little room for optimism in the near term.
- The company has managed to improve its gross margin through cost reduction initiatives, lower inventory de-stocking costs, and due to lower shipping expenses.
- The firm has generated enough free cash flow to cover its dividends and has also remained on track with its cost reduction program.
- SWK appears to be attractively valued, based on a relative valuation approach.
- We maintain our "hold" rating.
Stanley Black & Decker, Inc. ( SWK ) engages in the tools and storage and industrial businesses in the United States and internationally.
We have been covering the company since August 2022 , and we have maintained a neutral rating on the stock for this entire period. Our pros and cons for the neutral view have included:
- The challenging macroeconomic environment has been depressing demand for products and services of firms selling non-essential, durable goods, like SWK.
- Efficient cost reduction initiatives to manage profitability
- Strong commitment to returning value to shareholders in the form of dividends and share buybacks.
We have also explicitly mentioned the importance of inventory management in our previous article.
In today's article, we will look at the firm's latest quarterly earnings report, to assess how the profitability of the firm has changed since our last writing, as well as how inventory levels have developed. At the same time, we will assess the current state of the macroeconomic environment, primarily the change in consumer confidence and inflation rate, in order to come up with a reasonable expectation of what the demand might look like for SWK's products in the near term.
We will conclude our article with an updated view of the valuation.
Quarterly earnings
Income statement
Both sales and earnings of SWK have declined compared to the same period in the prior year. Revenues came in around $4.0 billion, representing a decline of about 5% compared to the same period in the prior year. Decreased outdoor and DIY volume have contributed significantly to this decline. The Oil & Gas divestiture has contributed also marginally to this decline. On the other hand, the favourable FX environment has partially offset the negative effects.
Income statement (SWK)
Further, it is important to underline that despite the lower sales figures, SWK has managed to improve its gross margin meaningfully. Gross margin for the previous quarter came in at 26.8%, representing a 400 bps expansion compared to the prior quarter. The three primary factors that have contributed to the improved profitability have been:
- lower inventory destocking costs
- supply chain transformation benefits
- lower shipping costs
SG&A expenses have been relatively flat in absolute terms ($765 million) compared to the past year, but due to the declining revenue, in relative terms the costs have increased to 19.3% of sales.
The company's Global Cost Reduction Program has remained on track and has resulted in $875 Million of Pre-Tax Run-Rate Savings since the beginning of the program.
All in all, it is clearly visible in the income statement that the macroeconomic environment has remained challenging. Declining revenue driven primarily by lower sales volume indicates that the demand for discretionary, durable products remains weak. Looking forward, we do not expect significant improvements in the near term. While the inflation rate has significantly improved over the prior year, consumer confidence in the United States has deteriorated substantially since July 2023, approaching once again its historic lows.
For these reasons, we do not see a justification at the moment to upgrade to a more bullish rating. Our conservatism is also supported by the recently released guidance, in which the firm has communicated that its Full Year GAAP EPS is expected to be ($1.45) to ($1.00). The free cash flow forecast range of $0.6 billion to $0.9 billion has remained unchanged.
Inventory
Inventory management has been one of our primary concerns previously as we have been expecting that the de-stocking costs would negatively impact the firm's profitability. In the previous quarter, however, we have already seen de-stocking costs coming down and inventory levels normalizing.
The following chart shows how SWK's inventory level has been developing in the past years. We can see that inventories have been falling steadily from the peak reached in 2022.
This positive development has been also highlighted by the management:
"Inventory at the end of the quarter was $5.0 billion, down approximately $300 million from the prior quarter and $1.7 billion since mid-2022 as the Company's inventory reduction program yields results and supply chain conditions improved."
For this reason, we believe that looking forward, SWK is well-positioned for the next potential up-cycle and we do not expect any negative impact from excess/obsolete inventory in the near term.
Returns to shareholders
The firm has remained committed to returning value to its shareholders primarily in the form of dividends. (In the past quarter the number of shares issued has been higher than the amount bought back, therefore no value has been returned through buybacks.)
Important to note that while the EPS is negative, the free cash flow generated by the firm (about $360 million in Q3) is more than sufficient to cover the dividend payments, which have totalled about $121 million.
As the dividend is well-covered by free cash flow and the firm has a strong history - more than 50 years - of paying and growing dividends, we do not believe that the dividends are in danger. For this reason, in our view, the current 3.8% yield could be attractive for dividend and dividend growth investors.
Valuation
To estimate the fair value of SWK's stock, we will be using a relative valuation approach. The following table compares a set of traditional price multiples between SWK and the consumer discretionary sector median.
While some of the multiples are not meaningful here, due to the negative earnings, we have to point out that SWK is trading at a significant discount based on P/CF compared to its own 5YR average.
If we narrow our peer group to the Industrial Machinery industry, and to firms that have similar market caps to SWK, we can see that SWK's stock is one of the most attractively priced ones.
Also the earnings projections by analysts, which assume meaningful positive earnings for 2024 make us optimistic about the current valuation.
Before making an investment decision however, we need to keep in mind that the further progress of the cost reduction program as well as the uncertain macroeconomic environment could have material impacts on the validity of these projections.
Conclusions
Both revenues and EPS have been deteriorating compared to the prior year, which strongly signal that the demand for SWK's products has remained weak. Based on the current state of the consumer confidence in the United States we expect the weak demand to persist in the near future.
On the other hand, SWK has been successfully reducing its inventory levels and has incurred significantly less de-stocking costs compared to the prior quarter. This has had a positive impact on the profitability of the firm.
SWK has generated enough free cash flow to cover its dividends, and for this reason we believe that the dividend will likely remain safe and sustainable in the near term.
Based on the P/CF multiple, SWK appears to be trading at a discount compared to both its 5YR average and the P/CF of firms in Industrial Machinery industry.
For these reasons, we maintain our "hold" rating.
For further details see:
A Fresh Look At Stanley Black & Decker