Stanley Black & Decker Is Recovering But Needs More Conviction (NYSE:SWK) (2024)

Thesis

Stanley Black & Decker, Inc. (NYSE:SWK) performance has suffered since 2022. In my opinion, management is the key to superior returns. Management needs to execute and provide investors with confidence that they will turn the company around. SWK's relative valuation is fairly to undervalued. The coming earnings results should shed additional light on how management is performing. Further management conviction is needed to initiate a long position. I rate SWK a hold.

Introduction and Troubled 2021-2022 Performance

SWK is a global and diversified company providing hand tools, power tools, engineering fastening systems and many more accessories. Their customer bases are wide and operate in a vast number of industries including construction, manufacturing and automotive. Their products attract DIY consumers, professional trades and industrial companies. They own well-known brands such as Stanley, Black+Decker, DEWALT, Craftsman and more.

The company has two operational segments; Tools and Outdoor and Industrial. The company generates 60% to 65% of their revenue within the United States for the fiscal year 2023. As we can see from the below chart, SWK stock performance has struggled materially since 2022.

Since the beginning of 2022 SWK's stock price return and total return were -52% and -49% respectively as per below.

A combination of supply chain challenges and poor fundamental performance was the cause for the price of the stock to decline, which also led to a change in leadership. More specifically, this can be clearly seen in the earnings per share and free cash flow changes. Problems have started to appear in the company's fundamentals in 2021 and the stock price fells once it became clear to shareholders that this problem will not go away quickly.

As per the chart below, earnings per share started to decline from 2021 reflecting some of these issues.

In addition, the free cash flow story provides a clear reflection of the problems that the company had since 2021.

As we can see below, year to date free cash flow for Q4 2021 declined by $1.5bn compared to the year before. The primary reason was working capital. Management back then mentioned that this was part of the inventory moves they were making expecting strong demand. As discussed below, management seems to have miscalculated their forecasts.

However, 2022 was the tipping point. Q1 2022 saw free cash flow declining by $1.1bn relative to Q1 2021 with working capital being the main driver once again. The same pattern followed for Q2 2022 with free cash flow being $2bn less than Q2 2022 and at the same time a new CEO has been announced effective first of July 2022. Previous management clearly made an error in forecasting demand, which led to increased working capital, negative free cash flow and a decline in earnings.

Enter New Management

I believe that the new management has made some progress in turning SWK performance around. The fundamentals are already looking better as they tackled immediate issues; however, they need to demonstrate their ability to sustainably grow, expand margins and build a strong balance sheet.

Firstly, by Q4 2022 management managed to reduce working capital unlocking c.$0.6bn of cash flow. In addition, 2023 results indicate that the initiatives and actions they took helped the company to improve its fundamentals. Working capital was reduced by $1.1bn in 2023 and a total of $1.9bn since mid-2022. The cost reduction plan was also ahead of their initial targets achieving cost savings of more than $1bn.

The overall result for the business was that free cash flow improved by $2.8bn in 2023 when compared with the full-year results of 2022 as we can see below. Comparing 2023 and 2021 free cash flow, the 2023 free cash flow is not at the 2021 level, but it is moving towards the right direction.

During the Q4 2023 earnings call, management has highlighted what their focus is for 2024 onwards. They continue to target cost reduction savings to reach $2bn by 2025; this is another $1bn that will flow down as free cash flow if they achieve it. In addition, management continuous to make SWK a more simplified and focused business as they announced the sale of their infrastructure business. That deal has closed for $760m and management signalled that the proceeds net of taxes will be used to reduce debt.

Since 2020, old management has leveraged the company's balance sheet, leading to too much debt in my opinion. As we can see below, even though it remains at high levels, it is moving towards the right direction, as it reduced slightly. Management has committed to further strengthening SWK's balance sheet which is important to enable a more agile SWK.

Overall, the new management has taken the right steps to reposition and refocus the company to achieve the desired growth. So far, management has addressed supply chain and working capital issues, reduced debt and divested parts that will allow the company to focus on key markets.

In the coming earnings, investors should pay close attention in improvements in free cash flow, margins and balance sheet. As discussed above, management has taken the right steps to set the company for growth and they seem to have some momentum towards tackling the right areas, however, they have to do a lot more to turn this around and return to pre-2022 levels. Hence, the coming earnings on the 2nd of May are crucial to investors as it will provide another look through management's performance and will lead to further conviction that management can turn this around or not.

Relative Valuation

Below I compare SWK valuation with its competitors Lincoln Electric Holdings, Inc. (LECO), Snap-on Incorporated (SNA), Pentair plc (PNR) and Graco Inc. (GGG).

As we can see above, price multiples offer a fair to undervalued range for SWK. On a forward price to earnings per share ratio SWK is in the middle ranking 3rd, on a forward enterprise value to earnings before interest and tax SWK ranks 4th and on a forward price to cash flow ratio ranks 5th.

In addition, SWK faced significant issues with its business relative to its competitors and this is reflected in the stock price and total return performance over the last three years. SWK had the worst performance as its stock price declined by 56% and total return was -52%. The next worst performance was PNR with a total return performance of 29%.

The relative valuation indicates that this might be a good entry point for investors. The new management is focused on tackling key issues within the business, whilst it is also working towards strengthening the balance sheet and refocusing the company. Meanwhile, the relative valuation indicates that SWK is fairly to undervalued whilst the company is going through a turnaround. If management is successful in turning the company around, then this is a good entry point. However, management needs to demonstrate their ability to do so. In my opinion, further conviction is needed to do that and hence, upcoming earnings should be closely monitored by investors.

Lastly, SWK owns well-known brands which I think will help management to turn this around. The tools and outdoor segment which accounted for 85% of the company's 2023 revenues has well-known brands and captures various customer segments. Their brand portfolio should help them achieve growth and margin expansion.

Risks

In my opinion, there is ultimately one risk that SWK faces. The turnaround is based on management's ability to execute. As discussed above, management has taken the right steps but I need to see additional evidence on how they are performing on both the growth side of things and simultaneous margin expansion. They have tackled key issues such as working capital and costs improving the free cash flow, however, there is so much that management can do from the working capital and cost side of things as there is a ceiling. They need to demonstrate their ability to re instate sustainable growth, margin expansion and build a strong balance sheet to ensure they can deliver good long-term shareholder returns.

In addition, the current environment offers both challenges and opportunities for SWK. From one end, the restrictive monetary policy means that there are less house movements, lower customer spending and less projects that SWK tools can be used in the process. Even though the current policy is restrictive, it can change at any time. On the other hand, the $1.2tn United States infrastructure bill is a huge investment opportunity within the United States that should present SWK with multiple opportunities to grow. Hence, I consider the current environment for SWK as neutral, including both challenges and opportunities.

Conclusion

New management has taken the right initial steps to turn the company around. Further conviction is needed that they are able to generate sustainable growth, expand margins and build a strong balance sheet. The upcoming earnings are crucial in determining management's ability to execute. On a relative valuation basis, SWK is fairly to undervalued. Given how crucial management is in turning this around and providing superior return for shareholders, I rate SWK a hold at this level.

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