Investors are unlikely to buy stock in Stanley Black & Decker (SWK -2.41%) for what it is right now, but may want to consider what it could become in a few years' time.
Trading on 26 times earnings, the stock is hardly cheap on a conventional basis. However, if it continues its underlying growth trajectory and the headwinds caused by tariffs, foreign currency movements, and commodity costs were to abate, then the stock could turn out to be cheap after all. Here's the lowdown.
Headwinds continue to hurt Stanley Black & Decker
The nature of the beast was revealed early on in Stanley's earnings call when CEO James Loree outlined how the company suffered "$445 million of external pre-tax headwinds from tariffs, FX and the like, a significant portion of which were not and could not have been anticipated at the beginning of the year."
To put this figure into context, the company's pre-tax income was $1.13 billion in 2019. Loree would go on to state that the external headwinds "have averaged about $300 million a year" over the three-year period from 2017 to 2019.
Simply put, Stanley has been hard hit by rising commodity and tariff costs and unfavorable foreign exchange movements in recent years. Consequently, you could argue that the company's headline earnings figures aren't reflective of its ongoing potential.
Guidance for 2020
As you can see below, management expects organic revenue growth of 3% to lead to $0.40-$0.50 in EPS growth with management's cost reduction plan contributing a further $0.95. But a combination of tariff and foreign currency headwinds ($115 million in dollar terms) and a less favorable tax rate are set to hold back earnings growth. Without the $0.65 headwind to EPS, the company could have been set for earnings growth in the mid-teens.
The case for buying Stanley Black & Decker stock
In addition to the potential upside from an absence of headwinds in the future, bulls will also argue that the company has top class management who has positioned the company for underlying growth for years to come. This can be seen in three ways in recent years.
- Management initiatives to consolidate the industry through acquisitions and develop sales in brands in the tools & storage (77% of segment profit in 2019) segment.
- The security segment (6.3% of segment profit in 2019) has been turned around, and Loree believes the business is at "inflection point with increasing positive momentum in organic growth and a stable operating margin rate poised for accretion in 2020."
- As you can see in the chart above, management has done a good job with reducing costs, and its future cost cutting plans are intended to result in a $430 million to $640 million improvement in operating income by 2022.
The acquisition and development of brands like Craftsman tools (bought from Sears in 2017) and Lenox and Irwin brands (bought from Newell Brands in 2017) has added growth potential. In fact, management expects mid-single-digit organic revenue growth from the tools & storage segment in 2020.
Moreover, the company announced plans to buy aerospace fastener and component manufacturer, Consolidated Aerospace Manufacturing (CAM), for $1.95 billion contingent upon a timely return to service for the Boeing 737 MAX -- the deal could boost growth in the industrial segment (16.7% of segment profit in 2019) currently feeling the pinch from a weak industrial manufacturing environment.
Meanwhile, the turnaround in the security segment will strengthen the company's hand, should management decide to divest the business -- an update is promised by midyear.
Hidden growth potential
Putting it all together, Stanley's management is doing all the right things in a difficult end market environment. Consolidating industries in a downturn is usually a good idea, and the cost cuts are creating the possibility of leveraging future revenue growth into outsized earnings growth. An improvement in the industrial economy will also help, particularly if it's accompanied by an easing in trade tensions.
All told, the stock may not look superficially cheap right now, but there's plenty of growth potential down the line. It's definitely the sort of stock worth looking at given any market-led share price weakness.