Is Stanley Black & Decker a Buy?

There's a lot to like about toolmaker Stanley Black & Decker (SWK -0.01%). In recent years, its management has made some opportunistic acquisitions and investments that have placed the company in a position to grow sales and expand margin through the creation of cost and growth synergies. As a result, the long-term outlook is bright, but the stock has been in hit by near-term headwinds. Is this creating a buying opportunity, or is Stanley a stock worth avoiding? Let's take a closer look.

The bullish case

There are three related points to the optimistic case:

• The near- and long-term guidance outlooks give the stock an attractive valuation based on earnings and free cash flow (FCF).
• Many of the headwinds (tariffs, currency, rising commodity costs) holding back margin and earnings expansion in 2018-2019 are likely to disappear in the future.
• The company has ample opportunity for more acquisitions and margin growth in the coming years.

Image source: Getty Images.

Outlook and valuation

Management laid out its outlook during the recent investor day presentation, and the numbers look pretty impressive. The table below shows the key details. Based on management's guidance for 2019, and the current stock price of around $139, Stanley trades on a forward price-to-earnings ratio of around 16.2 times earnings for 2019. That's pretty attractive for a stock with high single-digit earnings-per-share growth opportunities, and even better if Stanley can augment organic earnings growth through acquisitions.

To get to its 2020-2022 earnings targets, management is assuming 50 basis points (where 100 basis points equal 1%) of operating margin expansion per annum and an increase in FCF conversion.

Data source: Stanley Black & Decker presentations.

Headwinds disappearing

Of course, if Stanley is going to achieve its targets, then it will be free of the kind of margin headwinds that have hit the company in the last year or so. In a nutshell, a combination of tariff impacts, adverse currency movements, and rising commodity costs caused $370 million worth of headwinds in 2018 and caused operating margin to decline to 13.6% from 14.4% in 2017.

Moreover, many of the headwinds are extending into 2019, and as such, CEO Jim Loree is expecting only "modest margin accretion for the total year."

However, the good news is that the headwinds should dissipate in the second half with a margin approaching 15% again. In addition, during the investor day presentation, management reminded investors that margin had expanded by 40bp annually from 2013-2017, making the 2020-2022 target for 50bp annual expansion seem attainable.

Frankly, it seems a reasonable assumption because tariffs surely can't rise forever, and history suggests commodity costs are cyclical. Moreover, management has demonstrated the capability to take action even if cost pressures continue to rise. For example, during the investor day presentation in May, Loree outlined that the company was able to offset all but 80bp of the 260bp margin headwind in 2018 through "price increases, cost management, and other techniques. To address these pressures and their carryover impact into 2019, we took out $250 million of cost in the fourth quarter 2018."   However, it's anyone's guess whether currency movements will be unfavorable or favorable in the next few years.

Growth through acquisitions

Loree has previously styled Stanley as being the "the consolidator of choice in the tool industry." It's a moniker that fits well considering the 2017 acquisition of the Craftsman brand from ailing Sears Holdings for $900 million.

Not only did Stanley get to consolidate a rival in power and hand tools, but the acquisition also marked its entry into lawn and garden equipment, a move that would be furthered by the purchase of 20% of lawnmower maker MTD Products for $234 million. In fact, Stanley sees lawn and garden products as a key growth area -- that segment is expected to grow to 15%-20% of revenue in 2020 from a negligible amount in 2018.

In addition, the acquisition of Newell Brands tools business in 2017 for $1.95 billion added a complementary suite of products in the Lenox and Irwin plumbing and electrical tools line. 

Putting it all together, Stanley has a good opportunity to expand Craftsman sales outside of its traditional Sears sales channels, and generate growth and synergies through with Lenox and Irwin, while expanding into new markets such as lawn and garden products. Throw in the long-term opportunity to grow in emerging markets, and there's little doubt that Stanley is a grower.

So, is Stanley Black & Decker a buy?

All told, it's a compelling proposition, but before jumping in, it's worth noting that there are still some near-term headwinds to be dealt with. For example, adjusted operating margin was just 10.7% in the first quarter, and management is expecting it to jump to near 15% in the second half; meanwhile, the trade conflict with China is ongoing.

In addition, weakness in the automotive sector caused management to lower its industrial segment full-year outlook from flat sales and margin growth to a modest decline for both.

As such, cautious investors might want to wait for a quarter or two to see if management maintains its full-year outlook before buying into a very interesting long-term story.