What’s Wrong with Stanley Black & Decker, exactly?

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Although the fact that Stanley Black & Decker (SWK 2.47 percent) reduced full-year earnings wasn’t unexpected given the numerous indications of declining consumer spending, the size of the reduction was. Investors are now looking at just $5–$6 after management had projected adjusted EPS of $12–12.50 for the year (which was then lowered to $9.50–10.50 in April). Such downgrades are punished by the markets, and the stock falls by more than 48% in 2022. What exactly is wrong, what queries must management address, and is it worthwhile to purchase the shares at this time?

What was expected to occur
In addition to integrating its acquisition of MTD, this was meant to be the year that Stanley capitalised on the boom in DIY tool sales that had been built up during the epidemic (lawn mowers, snow blowers, and outdoor power equipment). In the meantime, management should have been able to plan for increased profitability in the upcoming years by refocusing on its core tools and industrial (engineered fasteners) after selling a number of non-core businesses (electronic security business to Securitas for $3.2 billion, automatic doors business to Allegion for $900 million, and oil and gas pipeline business to Pipeline Technique). Additionally, as raw material and shipping prices declined throughout the year, management anticipated an improvement in profit margin.

What actually transpired

Sadly, things went in a different direction.

Continuous price and commodity increases exceeded expectations.

Some profits were reduced as a result of Russian business closures.

In the DIY tools sector, “slower demand trends in June,” according to CEO Don Allan on the earnings call, were caused by higher interest rates and pressure on consumer discretionary spending.

The weather-related “extremely late start to the Outdoor season” caused significant volume pressure in comparison to expectations and revenue, Allan added.

The management now anticipates a mid- to high-single-digit fall in tools & outdoor full-year organic sales, with declining margins, as opposed to the mid- to high-single-digit gain previously anticipated. Things worsen. In 2022, the industrial sector’s margin is anticipated to fall (almost 14% of segmental sales in the second quarter).

The lowered guideline and the response from management

You can see where the guideline drop from the adjusted EPS forecast for the first quarter comes from because I’ve duplicated the statistics from management’s presentation.

A number of initiatives were started by management to minimise inventory (a problem when sales decline), indirect spending, company complexity (organisational layers will be reduced from 12 to seven or eight), and supply chain structure.

With regard to the final factor, Allan stated that Stanley’s lengthy supply chain is “not well aligned with the fast cycle nature of our operations” and “we believe being closer to the client is the proper answer.” Investors have a right to question why this conclusion wasn’t made earlier, or at the very least before former CEO Jim Loree left his position in June and left guidance that was substantially higher than it is now.

The cost-cutting strategy

Corbin Walburger, the temporary CFO, and Allan laid forth Stanley’s cost-cutting strategy. By the end of 2023, they expect yearly expenditures to be reduced by about $1 billion, starting with $150 million to $200 million in the second half of 2022. By 2023, the supply chain transformation will save $500 million annually, while the remaining $500 million will be generated by reducing indirect costs ($200 million), streamlining the corporate structure ($200 million), and lastly eliminating organisational layers ($100 million).

Management also sees a chance to reduce supply chain transformation expenses by an additional $1 billion over the course of three years. Within three years, it will result in cost savings of $2 billion.

Where possible, management intends to “further accelerate investment” in its commercial projects with the funding (innovating in power tools, investing in outdoor power equipment, auto fastening solutions for equipment for electric vehicle manufacturers, and investment in digital marketing).

What is the stock’s value?

Walburger contends that annualizing the $3 in EPS expected for the second half of 2022 and then include the cost savings planned for 2023 would bring you to approximately that figure. In the end, management sees a path to around $7.25 in adjusted diluted EPS by 2023.

Let’s say you budget $7.25 in EPS for 2023. The stock then trades at a price-to-earnings ratio of 13.4 times 2023 earnings, with an additional $1 billion in cost savings and an increase in underlying margin as volumes increase from a low base.

Although it is a strong argument, management won’t be able to win back investors’ trust for at least a few quarters. The bulls will think that when Allan begins his role as CEO, he decided to reset expectations during a “kitchen sink” quarter. The bears will be concerned about more guidance reduction if Stanley has trouble increasing sales and lowering inventory.

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