There’s a lot going on at Stanley Black & Decker (SWK). Meaningful improvements to the business and a strong remodel/renovation market have supported healthier trends in Tools & Storage, while the sudden, sharp decline in auto builds has made life difficult in that business, and management still doesn’t seem to have made up its mind on the Security business. On top of that, the company has launched an aggressive cost reduction program, with a prominent place given to automation, and management seems keen to pursue reshoring.
When I last wrote about Stanley Black & Decker, I wasn’t inclined to chase and thought there would be opportunities to buy on dips. I certainly wasn’t expecting the crater that was to come with the COVID-19 panic, but the shares have done a little better overall than the average industrial since that last piece. While Stanley Black & Decker is not as cheap as I’d like, I do like the momentum in this business and the possibility of both above-average growth and margins after a period of underperformance.
More Resilient Than Expected
Stanley Black & Decker has held up better than expected through this downturn so far, helped in no small part by both a strong underlying market for tools and the efforts made to improve this business prior to COVID-19 (new product intros, expanded retail distribution, etc.). I’ve been even more impressed with the margin performance, particularly in the context of a couple of years of frustrating underperformance.
Revenue fell about 17% in organic terms this quarter, a little better than the 19% drop expected by the sell-side. Gross margin declined 130bp, operating income fell 27% (with margin down 200bp), and segment profits fell 24% (margin down 160bp), beating expectations by 25%.
Tools & Storage (or T&S) saw a 15% revenue decline driven entirely by volume. Sales in North America declined 10%, and power tools (down 9%) outperformed hand tools and storage (down 23%). With more people spending more time at home, there’s definitely been an uptick in DIY home projects, and Stanley Black & Decker has been benefiting – particularly with one of its significant competitors, Techtronic (OTCPK:TTNDY), hamstrung by tariffs. Segment profits fell 17%, but margin was steady at 17% – less than a point off the Q2’17 level and off only 180bp from the Q2’16 all-time quarterly peak.
The news isn’t as good in the Industrial business, as weakness in the auto, aerospace, and oil/gas industries is all coming at once. Revenue declined 29%, with a 35% decline in engineered fasteners (auto and aero, predominantly) and a 19% decline in infrastructure (more oil/gas). Segment profit declined 57%, with margin nearly cut in half (down 760bp to 8.8%).
The oft-maligned Security business hung in there, with revenue down 8%, helped by a strong recurring revenue component (40%-plus of sales) from monitoring. Segment profit declined 11%, with a 260bp decline in margin.
The resiliency of the residential construction market (including renovation/remodel) has been a definite emerging theme – Illinois Tool Works (ITW) posted 12% growth in its residential construction business for the second quarter – and I expect strong resi into 2021. That has clearly helped Stanley Black & Decker’s T&S business, but again, I’d note that the company had multiple initiatives underway prior to COVID-19 that are also paying off – particularly new product intros and expanded retail distribution.
I do have some concerns that the company could be facing tougher comps next year at a time when other short-cycle names are posting stronger recovery growth, but I’d call that a good problem to have on balance. I’d also note that management has made it clear that they are impressed with the performance of MTD so far (gas and electric outdoor tools) and they intend to acquire the remainder of the business, potentially adding $3 billion to 2022 revenue.
MTD isn’t the only opportunity I see for Stanley Black & Decker. The tool space is still pretty fragmented. While SWK has about 15% share and a couple of other players have close to 10% share, there are plenty of sub-5% players out there. With both Emerson (EMR) and Ingersoll Rand (IR) having non-core/non-strategic tools businesses, and M&A ambitions of their own outside the tool space, I could easily see Stanley Black & Decker making another deal or two, though it might be harder to make that work financially after the MTD deal.
Waiting For Other Industrial Markets And A Final Decision On Security
There’s not a whole lot new to say about Stanley Black & Decker’s exposure to the auto, aerospace, and oil/gas markets, or at least not if you’ve read my other industrial articles. I expect a pretty strong auto recovery starting late this year and continuing through 2021, and that should drive improving build rates and demand for SWK. Longer term, I do see content growth opportunity in hybrids and EVs. Aero and oil/gas don’t look as promising to me, as I think both sectors are looking at multiyear recovery trajectories.
Although SWK doesn’t have infinite capital lying around, I could also see fasteners being an area of future spending. This area, too, is still pretty fragmented, and I think there are several specialty fastener businesses that the company could consider. Deals in tools probably make more sense from a risk-adjusted total return perspective, but there are opportunities here.
Management’s comments on Security didn’t suggest that a decision was imminent on whether the Security business would stay or go. This business has been “on notice” for a while, but management seems reluctant to move – perhaps because the prospective value of jettisoning, the business is still unattractively low. I don’t think Security hurts the business in the near term, but the uncertainty of the company’s commitment here is going to impact the business at some point.
With first quarter earnings, management introduced a $1 billion cost reduction plan and then updated its estimate of the permanent portion of that to $650 million. This is a far-reaching plan that goes beyond cutting corporate travel, country club memberships, and mass-firings of workers. This is more of an organizational transformation, and it includes a pretty significant embracing of automation and AI.
Stanley Black & Decker has partnered with Rockwell (ROK) to automate its manufacturing, and the company has some aggressive reshoring targets, including a “dramatic” reduction of its China manufacturing footprint over the next three years. Stanley Black & Decker is, so far, one of the few companies to really announce a meaningful reshoring intention, and one of the potentially overlooked benefits of this will be a lower level of working capital needed to support the business.
Management just boosted its growth target for the third quarter, with 7% to 10% growth guidance against an expectation for a small decline. The tool business continues to drive that positive momentum. I haven’t really changed my long-term expectations all that much, though, as I’m looking for five-year growth around 4% and longer-term growth also around 4%, with improving margins and FCF margins driving high single-digit to low double-digit FCF growth. If the reshoring initiative is successful, reduced working capital needs could offer some longer-term upside to FCF margins beyond the low double digits.
The Bottom Line
Few industrials look cheap these days. In the case of Stanley Black & Decker, I find it interesting that the shares look a little undervalued relative to the sector despite stronger near-term growth potential, evidence of real margin improvement, and longer-term FCF improvement potential. While this company isn’t really superior in quality metrics like ROIC, I do think the relative upside and the potential for beat-and-raise quarters and an auto recovery in 2021 make this a name worth owning for now.
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.