Stanley Black & Decker Slumped, but Is It a Buying Opportunity?

Earnings season is here, and the market showed it's in no mood to tolerate any company talking about cyclical weakness when it marked down toolmaker Stanley Black & Decker (SWK) by more than 15% on the day of its fourth-quarter earnings presentation. Has the market overreacted and created a very good buying opportunity with Stanley Black & Decker stock? Let's take a close look at what you need to know before buying the stock.

What Stanley Black & Decker's management said

CEO Jim Loree left little doubt in investors' minds that the company's end markets are slowing in 2019. Answering a question from Nomura Securities analyst Michael Wood during the earnings call, Loree pointed out that economic growth in 2019 would be "probably a good point lower than it has been in the recent couple of years. And then on top of that, it's no secret that the construction markets in the United States have slowed as well." 

Image source: Stanley Black & Decker website.

Going into more detail regarding trends in the company's core tools market, Loree outlined that the slowing started in the third quarter "concurrent with the interest rates increases that were being implemented by the Fed. And we saw the same thing in automotive as well, the interest rate sensitive type markets, housing, automotive, impacted by rising interest rates."

Turning to how these feed into guidance for 2019, the table below clearly shows the slowing growth trends implied in management's guidance. As you can see below, organic revenue growth is expected to slow markedly from the rate achieved in the fourth quarter of 2018 and the guidance for low single-digit earnings growth implies ongoing margin pressure. 

Data source: Stanley Black & Decker presentations. Guidance notes by author.

That said, the midpoint of 2019 earnings guidance means the shares trade on just 13.5 times forward earnings guidance (see chart below for historical price-to-earnings multiples), and it's not as if growth is turning negative. Is the market being too pessimistic on the stock?

SWK P/E ratio (TTM) data by YCharts.

There's a lot to like about Stanley Black & Decker

The case for buying the stock isn't just based on a value opportunity created by a market overreaction, as there's also a good argument for believing in management's long-term vision. In a nutshell, Loree believes the company is well placed to grow through the cycle. 

For example, the opportunistic acquisition of the Craftsman brand from Sears in 2017 and the purchase of the tools business of Newell Brands (NWL -1.08%) has given Loree's company the opportunity to add growth and generate synergies. Meanwhile, Loree believes that " by the end of '19, we're going to be in really great shape from a balance sheet perspective," and this could augur well for the company's capability to make more earnings enhancing acquisitions.

In a nutshell, Stanley Black & Decker doesn't trade on a demanding valuation, and as the best-run company in its sector, management is positioning the company to take advantage of any cyclical weakness in order to strengthen it for the long term.

Not enough to make the stock a buy

It's a compelling argument, but I think investors should err on the side of caution here. There are three factors to consider.

First, CFO Don Allan pointed out that the margin headwinds hitting the company (tariffs, commodity inflation, and currency) would see their greatest impact in the front half of the year, causing "first-quarter earnings to be approximately 13% of the full-year performance" compared to 17% for the full-year of 2018. This means investors are going to have to wait until at least the second half before seeing margin improvement.

Second, as Loree pointed out the interest rate-sensitive sectors (housing and automotive, for example) are slowing and trends may get worse if rates keep rising. Moreover, a slowing sales environment is not the ideal backdrop for a company trying to expand sales of acquired brands. 

Third, the reasons why the global economy is slowing (trade disputes, political uncertainty in Europe, rising rates) are not necessarily going to be fully resolved in 2019, but management's outlook calls for growth across all its sales regions.

The bottom line

All told, it's a stock for the watchlist. Any sign of a better economic outlook ahead and this is the sort of stock that will fly, but unless you are very confident in management's outlook, investors who buy in now will have to wait a few quarters before seeing tangible improvements in margin.

Check out the latest Stanley Black & Decker earnings call transcript.