Why Emerging Markets Are Important for Stanley Black & Decker

Stanley Black & Decker looks attractive, but its prospects depend partly on its emerging-market performance. Meanwhile, industry peers like Snap-on have being saying positive things about the industrial sector, and home-goods company Whirlpool is doing well in emerging markets. So, what to expect from Stanley Black & Decker?

Jul 7, 2014 at 1:17PM

One of the most consistent investment themes of 2014 so far has been that developed markets have gotten relatively stronger, while emerging markets have weakened. Therefore, what to do about Stanley Black & Decker (NYSE:SWK)? The stock looks like a good value, and there are plenty of reasons to like it, but a large part of its growth prospects depends upon emerging markets. With that said, what are home improvement peers like Whirlpool (NYSE:WHR) and Snap-on Incorporated (NYSE:SNA) saying about end markets, and what should Fools consider before buying into Stanley Black & Decker?

Why emerging markets matter to Stanley Black & Decker
Back in October, investors were treated to an eye-watering mid-teens slump in the stock price as the company lowered its full-year 2013 guidance by more than 10%. The problems in 2013 were focused on the difficulty in raising margins in its security segment (particularly from its acquisition of Swedish security company Niscayah), and weaker growth expectations from its industrial and Construction Do-It-Yourself, or CDIY, segments. In particular, emerging markets had slowed, and sequestration effects had hit U.S. governmental revenue.

All of which suggest the company was too optimistic in its previous strategic growth plan. However, the plan has been updated since, and investors can see the changes below. The idea is to increase its revenue run-rate within three years to the figures quoted below.

Previous InitiativeAnnualized (in millions)Current InitiativeAnnualized (in millions)
Emerging Market Expansion $350 Emerging Market Expansion $350
Healthcare & Security $150 Healthcare & Security $150
Smart Tools & Storage $100 Smart Tools & Storage $100
Offshore Oil & Gas $100 Offshore Oil & Gas $100
Remaining Merger Synergies $50 Remaining Merger Synergies $150
U.S. Government $100    
Total $850 Total $850

Source: Stanley Black & Decker presentations.

In other words, the total target is the same, but expectations for an improvement in the U.S. government have been muted, while acquisition synergies have been upgraded. Clearly, the biggest question mark over the initiative -- and therefore the stock price -- is likely to be over the likelihood of it hitting its plan in emerging markets.

Stanley Black & Decker's recent results were mixed
Fast-forward to its recent first-quarter results, and there are a few key takeaways that only confirm the importance of its emerging-market plans. A look at segmental profit in the first quarter illustrates how the company generates its earnings.

Stanley

Source: Stanley Black & Decker presentations.

First, the CDIY and industrial segments reported a good set of results in the first quarter. CDIY sales increased 6% (7% due to volume) with organic sales up 11% in Europe. Emerging-markets organic growth was 7%, and despite the poor winter weather, North American organic sales increased 5%. However, the star performer was the industrial segment, where sales rose 16% (12% growth due to acquisition) and management outlined that "a stronger performance in our industrial business is now expected, both on a volume basis and a profitability basis for the remainder of the year." In fact, the strength in the industrial sector caused the company to raise the bottom end of its EPS guidance by $0.05; it now stands at $5.35-$5.50.

Rival company Snap-on's recent results also confirm strength in the industrial sector. Snap-on's commercial and industrial segment increased sales by 9.1% in the first quarter, while its tools group generated a 5% increase. Moreover, Snap-on's management cited "continued sales increases in our European based hand tools business" as a reason for the improvement in commercial and industrial -- suggesting European end markets remain favorable for Stanley Black & Decker.

Second, although the benefits of the restructuring of the security segment are taking longer than expected to come to fruition, Stanley Black & Decker's management outlined that it expected operating margins to improve incrementally in the back end of the year. Security sales decreased 3% in the quarter, and there is much to do operationally -- particularly in Europe -- but management expects a "gradual, linear type of improvement over the next two years." Moreover, the market is already aware of the issues.

With the market now aware of improving industrial conditions and progress in the security segment, the swing factor directing its share price is likely to be its performance in emerging markets.

Whirlpool and Stanley Black & Decker on emerging markets
There is no doubt that conditions in emerging markets have weakened, but Whirlpool recently gave some positive news on the issue. For example, Whirlpool's management left expectations unchanged for its industry demand assumptions in Latin America (flat) and Asia (flat to plus 3%). Moreover, Whirlpool's strength in emerging markets is in Brazil -- where others have reported weakness -- so the fact that it left guidance unchanged is a positive sign. However, this is probably more indicative of Whirlpool's particular performance in Brazil rather than broad-based economic strength.

Turning back to Stanley Black & Decker, the commentary on the recent conference call was rather confusing. Management declared it was "about on track in emerging markets," but then outlined that Latin America only grew in the low single digits, "below our expectations." Moreover, even though Asia "continued to do well," management "tempered" its expectations for Asia as a result of lower growth in the China economy. Clearly, the pressure is building on the company to continue to exceed market growth in these regions.

The bottom line
Snap-on's results were positive for continued growth in the industrial segment, and Whirlpool gave some positive commentary on its performance in Latin America, but it too is somewhat reliant upon outperforming the competition -- something that may not necessarily last.

All told, there is a lot to like about Stanley Black & Decker, but Fools should be aware of the importance of emerging markets to its growth plan and the need to execute with its security division. On a forward P/E ratio of 16 times analyst estimates for 2014, the stock looks like a good value, but any further weakening in emerging markets may cause the company to readdress its expectations.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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