2024-01-03 08:14:37 ET
Summary
- Stanley Black & Decker continues to face challenges, including overstocking, slowing customer demand, and difficulties with acquisitions and high debt.
- Management has implemented a cost reduction program and is focusing on destocking inventories and reducing debt and is doing all the right things.
- The outlook for SWK is relatively weak, with slow sales growth expected and concerns about long-term growth prospects in the industry.
- At current levels SWK is a 'Hold' but will monitor for any weakness (10% plus drop) to consider initiating a position.
Stanley Black & Decker (SWK) is one of, if not the leading producer of power tools and fasteners globally, though with a heavy presence in the US. According to the company website , it operates two core segments with four sub segments: In its Tools & Outdoor segment, the subsegments include Power Tools & Equipment, Hand Tools, Storage & Accessories, Outdoor Power Equipment. In its Industrial Solutions segment, subsegments include STANLEY engineered fastening and infrastructure.
In the past few years the company has faced some major challenges relating to significant overstocking of inventory, slowing of customer demand due to a correction in the housing market, and difficulties digesting some of the major acquisitions it has made in recent times and dealing with the high debt overhang that enables these acquisitions. Looking ahead, significant challenges remain including lower demand post-COVID due to problems such as high and sticky inflation, and more external competition.
To fight these headwinds, management started a major global cost reduction program, aiming to deliver US$2bn in run-rate savings by 2025, which delivered US$875m pre-tax savings in 2023 up to Q3. Other major focus areas have been destocking inventories, rationalizing some of its businesses and reducing debt.
In this article I present a view on SWK's post-Q3 2023 earnings, going into FY earnings on to be announced on February 1st, 2024. I also assess the company's operating performance and present an outlook for 2023 full year and beyond.
In preview, I believe SWK is trading at roughly fair value (+2% potential upside), while any economic deterioration poses risks. At this level I believe the stock presents a relatively unfavorable risk/reward opportunity. In the short-term I do not expect the stock to take off and believe current prices leave no margin for safety for investors looking to start a position in this stock.
Overview of Stanley Black & Decker
As a power tool and industrial fasteners company, SWK relies primarily on its product and brand strength to compete in the global tools & outdoor business. In 2022 , SWK's Tools & Outdoor revenues accounted for 85% of total revenues (c.40%, Power Tools & Equipment, c.24% Hand Tools, Storage & Accessories, and Outdoor Power Equipment accounting for c.21%). SWK's Industrial revenues accounted for c. 15% of total revenues (Fastening business accounting for 11% and Infrastructure for 4%).
Its Tools & Outdoor products include globally recognized brands such as DeWalt, STANLEY, Black + Decker, CRAFTSMAN etc.
Looking at SWK's geographic coverage gives some indications as to where growth and challenges will come from going forward. In 2022 the US accounted for c.63% of revenues, Europe accounted for 15%, Emerging Markets for 12% and the rest of the world for 10%. While the US economy has proven highly resilient in recent months with core inflation slowly coming down and rate cuts on the horizon, the outlook for the DIY market is not particularly strong. According to Statista , the US DIY & Home Improvement market is set to grow by 2.56% in 2024, while the Global DIY & Home Improvement market is set to grow by 2.72%. To put this into context, the St Louis Fed forecasts a 1.3% real GDP increase in 2024. CEO Don Allan mentioned in the Q3 earnings call "And so I think the topline next year, we are expecting a similar stablish type macro environment with some dynamic elements around it, but it's really going to depend on our volume next year, is really going to depend on has the consumer stabilized and the rebalance between goods and services and has the outdoor business stabilized post-COVID". In my view, with a weak economic forecast for 2024, and the slow expansion of the DIY & Home Improvement market in the US and globally, I am not overly optimistic about SWK's prospects for 2024.
Stanley Black & Decker 1H Results Presentation
Macro Growth Drivers
I always like investing in industries that have strong (and common sense) growth drivers. For the Tools & Outdoor segment, my current concern is that I do not see these strong macro drivers in place. Macro growth drivers for this sector include:
Growth in Construction
An increase in residential and commercial construction projects, as well as infrastructure and home improvement and renovation projects drive the demand for power and hand tools. However, looking at the major markets of the US and Europe, I believe this activity to be relatively weak for 2024 due to slow economic growth.
Growing DIY trend
The growing popularity of the DIY trend for home improvement and renovation projects has increased the demand for power and hand tools among homeowners. This is a trend I do see, especially as people are looking to save money on outsourcing home improvement projects by doing it themselves. However, I would argue that this trend also is not a major driver of growth, as many who are willing and able to engage in DIY projects are likely to rely on existing tools, rather than purchase new ones. For instance, I have a Black + Decker power drill that's over a decade old that I still use as the quality is simply that good. Even if I want to undertake more DIY projects at home, I would not need or want to buy a new power drill. Hence I remain skeptical of growth prospects. While this trend is accelerating overseas in places like China and other emerging markets, SWK faces more competition here from local (and cheaper) brands.
2023 Q3 Interim Results
When looking at the Q3 Interim results, SWK had a mixed performance year-to-date, with weak sales due to the deterioration of economic sentiment in the 2nd half of 2023. SWK posted organic revenue decline of 4% compared to Q3 in 2022. The decline was driven mainly by lower Outdoor & DIY volume, as well as destocking of the Attachment Tool segment.
Bright spots were regarding its global cost reduction programme, delivering US$875m of pre-tax run-rate savings since inception and on track to deliver the US$2bn savings by 2025. This is a highly necessary project that I will continue to monitor closely going forward. Gross Margins also improved 2.9% vs. prior year, and inventory was reduced by US$880m in 2023 up to Q3, on track to deliver US$1bn by year end.
Stanley Black & Decker Q3 Results Presentation
Overall SWK continues to benefit from its strong brands which are a major moat in this industry, which in turn gives SWK strong pricing power.
Another area that management highlighted was the progress in inventory destocking, with ~US$0.9bn in inventory reduction in 2023 up to Q3. Inventory reduction is expected to continue through the end of 2025 at least. While the destocking has been impressive, what concerns me is that the inventory levels are still well above historical averages. In 2018 SWK had inventory days around 95, today they are still above 150. So while destocking progress is promising, they have a long way to go.
Outlook - 2023 and Beyond
Looking ahead at 2023 full year and beyond, I believe the outlook for SWK is relatively weak. The same trends reported in 3Q23 are likely to persist - weak sales, partially offset by cost and inventory reductions. In addition, as economic sentiment remains relatively subdued for 2024, I do not believe that SWK will be able to continue benefiting from its strong pricing power as some consumers will consider trading down and buying substitute brands. I expect overall revenues to decline by c.3-4% for 2023 FY, and off this relatively low base, I believe that SWK is likely going to be able to grow its revenues by roughly 3.5-4% going forward. At the moment I do not see any major other macro growth drivers that could make future growth prospects more enticing.
Stanley Black & Decker Q3 Results Presentation
Taking a long-term view and looking beyond 2023 and even 2024, I believe the future of SWK's success will depend on a few key factors:
Cost & Inventory reduction
I believe SWK will be held very much accountable by the capital markets as to whether or not they achieve their run-rate cost savings target by 2025. The same goes for reducing their inventory levels and freeing up working capital for investment into R&D / growth. If they fall short of their targets, further weakness lies ahead.
Growth
While SWK has world leading brands, I believe it will need to continue to grow their brands across existing geographies (outside of the US) to maximize its existing product potential.
In addition, as SWK mentions is part of their strategy, they will need to expand their product lines through innovation and electrification. The success of these innovation is one of the key potential growth drivers that could lead to a higher equipment replacement rate, and thus grow sales.
Operational efficiency
Wage and raw inflation plague virtually every industry, as such it will be important for SWK to mitigate these cost increases as much as possible to protect their margins and to avoid having to increase their prices too significantly, which runs the risk of alienating certain customers.
Stanley Black & Decker Turnaround Strategy
Overall, I am neutral about SWK's future in the next 1-2 years, as I believe market growth is going to be sluggish, and they have a lot of problems to address (debt, cost and inventory reduction) that will have major ramifications for future success. Despite these challenges, I do believe that management is doing all he right things, and the business has a strong moat in the form of its strong brands and high product quality which makes it more resilient in the long-run. My major concern remains the long-term growth prospects of this industry. Should that concern be alleviated, I think SWK is well positioned to be a great long-term pick for patient investors.
Valuation
SWK's shares are up 28.89% in the last year closing at US$98.2.
Over the last 5 years, shares are down 18.66%, down c. 55% down from its all-time high of US$216.8 (May 2021). Looking ahead I am moderately positive about future earnings, mainly due to management's track record of delivering on is cost savings target, its inventory and debt reduction. However, I do believe most of this is already being priced into the current share price, and thus I do not think SWK will go much higher in the near to medium term, due to slow sales growth going forward. Based on my DCF model, I have a long-term price target of c.US$99.8, so I will round up to US$100, indicating a potential upside of 1.8%. As such, I believe there is no sufficient margin for safety at current prices and will wait for more attractive buying opportunities. I myself am interested in starting a meaningful position if shares dip below US$90 and would more bullish around US$88.
In addition, SWK currently pays a quarterly dividend with a 3.30% yield - I do consider this an attractive yield, especially since SWK has been growing its dividend for the past 56 years, making it a Dividend King. I believe dividend increases will continue as SWK's management will want to maintain its Dividend growth streak, but I expect them to be very modest (1-3% annually).
Seeking Alpha
Looking at the ratings summary, I concur with Wall Street & SA Analysts in that SWK currently is a 'Hold'. Since I am interested in dividends, SWK's 3.30% yield and Dividend King status is quite appealing. However, due to the low margin of safety I will wait for a lower entry point.
The SA Factor grades are generally in line with my views, especially the 'D-' for growth.
Takeaway
Stanley Black & Decker is currently trading 55% below its all-time high and offers a dividend yield of 3.30%. Based on a DCF analysis, I see only 1.8% potential upside, and thus believe the stock is a 'Hold'.
In the past few years, the company has faced some major challenges relating to debt, inventory and cost structure, all of which management is actively addressing and making progress to resolve. The one major challenge that is outside of management's control however is slowing of customer demand, which I believe dims prospects for SWK going forward. Any economic deterioration could pose additional term risks. At this level I believe the stock presents a relatively unfavorable risk/reward opportunity. In the short-term I do not expect the stock to take off and believe current prices leave no margin for safety for investors looking to start a position in this stock. I would wait for the stock to drop back to around US$88-90 before starting a position. For those already holding SWK stock, I recommend holding tight and wait and see.
For further details see:
Stanley Black & Decker: Turnaround On Track But Growth Prospects Are Worrying