Stanley Black & Decker Comes In A Little Light, But Has Drivers For 2020

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Summary

The last year has been fairly good for Stanley Black & Decker (SWK) despite significant headwinds from tariffs, the U.S. dollar, and challenging conditions in the auto end-market. Helped by growth in the tools business, Stanley Black & Decker’s organic growth held up better than most multi-industrials, and there has been further progress in the Security business.

When I last wrote about the stock, I recommended picking up SWK shares if and when they fell below $140. Investors got two of those opportunities, and the shares have solidly outperformed the industrial sector and the S&P 500 since the last one. At this point, even with what is likely to be an above-average organic growth profile for 2020, I think the shares are little pricier and I’d be more interested again in the $150’s.

A Mixed Quarter

Stanley Black & Decker’s fourth quarter results are likely to stand out once again from the company’s multi-industrial peers, with overall organic growth of 2% likely to only be surpassed by a relatively small number of companies. Even so, it wasn’t a perfect quarter, as the company did come up short on revenue and margins.

Organic revenue of 2% growth still led to the company coming up about 2% short of expectations, with Security being the lone outperformer. Tools & Storage (or T&S) revenue rose 2% in organic terms, missing by around 2%. Industrial saw 4% revenue contraction, missing by almost 3%, with flat results in engineered fastening and a steep decline in infrastructure. Security rose 4%, beating expectations by 1% on balanced contributions from volume and price.

Gross margins declined 160bp, coming in below expectations. Operating income rose 5%, with 30bp of margin expansion, while segment-level income rose 7% with 70bp of margin expansion. Segment income missed expectations by about 1%, with slightly better than expected margins overall. Industrial and Security both missed modestly at the segment profit line, with margins up 40bp and down 80bp respectively but better profits in T&S (margins up 110bp) helped offset that.

For the full year Stanley Black & Decker did well on FCF, with a 7.5% margin above the trailing long-term average.

Digging Into The Details

On the whole, I’d say the details of Stanley Black & Decker’s performance were fairly undramatic.

The T&S segment saw modest volume growth (up 1%) against a challenging comp, and the power tools business continues to grow well. New product introductions in DeWalt should offer some positive leverage, as well as past decisions to expand Craftsman retail distribution. Tariffs continue to be a mixed issue for Stanley Black & Decker – while it does create some challenges on the margin side, rival Techtronic (OTCPK:TTNDY) has had to put through some meaningful price hikes to compensate for tariffs.

In the Industrial business, auto fastener sales did decline at a low single-digit rate (around 2%), but the company also managed to beat underlying auto builds by about four points. Weakness in the oil/gas pipeline business pressured the infrastructure segment.

In Security, the company saw strong 7% growth in North America on increased commercial installations, as well as good results in healthcare and doors. Europe was considerably weaker, but still positive with 1% growth. As a reminder, the clock strikes midnight on the company’s “improve or get out” initiative with this division. The business has definitely improved, margins are back in the low double-digits, and while I do think Stanley Black & Decker will look to exit this business, I believe they’ll do so opportunistically.

Paying The (High) Price To Diversify Into Aerospace

In conjunction with the earnings, Stanley Black & Decker announced that it will be acquiring Consolidated Aerospace Manufacturing, a manufacturer of aerospace fasteners, for $1.5 billion, with $200 million of that contingent on FAA reauthorization of the 737 MAX. The purchase price is further modified by $185 million in expected cash tax benefits, but even in a “best case” scenario Stanley Black & Decker is still paying roughly 14x trailing EBITDA (and almost 19x on a “fully loaded” basis).

To be sure, buying into aerospace is rarely cheap. Eaton (ETN) paid 12x EBITDA for Souriau-Sunbank (a manufacturer of aerospace connectors) and Parker Hannifin (PH) paid about 13x EBITDA for Exotic Metals (a manufacturer of engine and airframe systems). Moreover, this will diversify the company into a market with attractive long-term fundamentals that will further offset some of the company’s short-cycle exposure, while also potentially providing significant accretion in Year 3 post-deal.

The Outlook

Management’s EPS guidance was a little light, with a midpoint about 1% below the Street’s average estimate going into the quarterly report. It looks like management is baking in some “wiggle room” here, though, and it looks like the first quarter will be the roughest of the year – that’s pretty consistent with what industrial companies who’ve reported to date have suggested as well. On a more positive side, the company’s strong exposure to the U.S. residential repair/remodel (more than a third of T&S and about a quarter of revenue overall) should be a good driver, particularly with the remodeling index at a recent two-year high.

Including the CAM acquisition, I’m looking for long-term revenue growth of around 4% from the company, and gradual improvements in margins and asset efficiency should drive FCF margins into the low double-digits, pushing the FCF growth rate into the high single digits.

Discounting the cash flows back to today, I believe Stanley Black & Decker shares are priced for mid-single-digit returns that are a little below what I see available in other high-quality industrials. Valuation is definitely more compelling on an EV/EBITDA basis, though, with the company’s margins and returns supporting a 12x forward EBITDA multiple that still suggests some upside from here.

The Bottom Line

Were Stanley Black & Decker to retreat back into the $150’s, I’d be a lot more bullish on these shares. As is, I’m impressed with management’s performance and I like the exposure to the residential repair/remodel market, but I’m not going to chase the stock to get it.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.