Stanley Black & Decker Fell 14%: Time to buy?

Investors buy the companies on the list of S&P 500 Dividend Aristocrats for stability and consistent dividend growth. It has been proven repeatedly that these large cap companies focused on increasing dividend payments each year have provided superior returns to the S&P 500. However, investors need to be reminded that even these "stable" stocks can plunge when management provides results or guidance that falls short of market expectations. That is exactly what is happening today with Stanley Black & Decker (NYSE: SWK  ) .

Why the drop?
Shares of Stanley Black & Decker dropped by as much as 16% following the company's third quarter earnings release. The reason for the plunge can be found right in the headlines of the release:

  • "2013 FY EPS Guidance Range, Excluding Charges, Revised To $4.90-$5.00 ($3.75-$3.95 On A GAAP Basis) From $5.40-$5.65 as a result of slower margin rate recovery within the Security segment, weakening emerging markets and the impact of the U.S. government shutdown on organic growth
  • Free Cash Flow Excluding Charges And Payments Revised To Approximately $800 Million Vs. Prior Estimate Of Approximately $1 Billion"

The company attributes about half of this decline in full-year guidance to weakness in its security segment, with the other half relating to weak international growth and the estimated impact of the U.S. government shutdown. Organic revenue growth of just 4%, a roughly 10% drop in full-year EPS guidance, and a 20% decline in free cash flow guidance to occur in just one quarter is a pretty substantial guidance reduction that has clearly spooked investors.

Looking at the big picture
Over half of Stanley Black & Decker's sales are generated from its consumer and construction segment, which makes a wide array of industry-leading hand tools under well-known brand names such as Stanley, Black & Decker, DeWalt, and Bostitch. Manufacturers of other home improvement and construction products such as W. W. Grainger (NYSE: GWW  )  and Fastenal (NASDAQ: FAST  )  have reported a challenging environment in recent months. In today's earnings release, W.W. Grainger reported 5% revenue growth and lowered its full-year revenue growth forecast to 5-8%. Meanwhile, Fastenal's revenue for the year has been limited to 6% growth.  Shares of both companies have fallen about 10% from their respective 52 week highs as a murky view of the remainder of 2013 has formed a cloud over stocks of the tool and supply manufacturers.

Interestingly, this cloud of uncertainty has yet to reach home improvement retailers such as Home Depot; Home Depot has exceeded earnings expectations all year. The company will not release Q3 earnings for over a month, but when it does it will be an interesting data point to determine whether home improvement and construction has hit a bump in an ongoing growth cycle or whether a new trend is forming.

What's next for Stanley Black & Decker?
While Stanley Black & Decker isn't the only company dealing with low organic growth and uncertainty in a number of markets, the company's shares are certainly being hammered today. To put this in perspective, there are a few things to consider:

  • The news is not all negative. While falling just short of analyst expectations, the company's total revenue increased 9.6% this quarter. Additionally, adjusted EPS of $1.39 beat analyst expectations by a penny and grew 14% over Q3 2012 adjusted EPS. 
  • Investors must remember why they purchased shares in the first place. Stanley Black & Decker is a dividend aristocrat with a history of stable, increased payouts for long-term investors. Investors should not be expecting 30% growth and multi-bagger returns from the company, and the prospect of a weak fourth quarter should not materially impact the investment thesis unless the underlying trends are expected to continue for a prolonged period.
  • Since dividend growth is often a significant reason for investing in Stanley Black & Decker, a more relevant area of focus is the company's cash flow and the likelihood that it can continue to increase payouts going forward. Prior to this quarter's earnings release, the company's payout ratio was just 37%. Given the noise of the company's merger and acquisition activity, it will be important to monitor whether the company returns to the "normalized" free cash flow  in the future. For example, this quarter's GAAP free cash flow was just $5 million, but the company is reporting normalized free cash flow of $71 million excluding the impact of M&A activity.  

What to do now?
For existing long-term investors, the answer to the question of "what to do now?" should be "nothing." This earnings release may have disappointed the market, but the long term outlook of the company has not changed. Management is working to generate growth through organic growth initiatives and additional acquisitions, the stock trades at a reasonable trailing price to earnings ratio of just 14, and there is no indication that the company's streak of increasing dividends every year for 46 years is in jeopardy. After all, the company has been strong enough to pay a dividend in 137 consecutive years!

Investors looking to start a position in a dividend aristocrat or add to an existing position in Stanley Black & Decker should consider giving the company a deeper look in the coming weeks and months; the expected headwinds during the fourth quarter could present a solid opportunity to invest in a company with a tremendous track record.

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  • Report this Comment On October 16, 2013, at 11:44 PM, AlbaFoolish wrote:

    Last year Stanley made a significant change in its security business by moving away from its differentiated 'direct to end user' business model to line up with the indirect approach taken by Ingersol Rand and ASSA Abloy. This move has resulted in driving some additional volume at a lower margin rate. There is concern that the increased volume is driven by dealer stocking orders and that they are not replenishing at the rate expected with this change in approach. I think that while such a sharp fall in share price normally would merit consideration for starting a position against the background of what may be an overreaction, in this instance I think this is a case of buyer beware. I believe it might be better to watch what happens over the next couple of quarters. Security is a substantial contributor for Stanley and if all is not well the next few quarters will reflect that. Given the timing of the Government shutdown relative to their quarter end, it is hard to see a significant impact within the third quarter. I was surprised that this was not challenged on the earnings call. Time will tell.

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