Stanley Black & Decker (SWK 1.53%) is one of the most compelling investment opportunities in the industrial sector. A combination of operational improvements, growth opportunities, and disappearing cost headwinds means earnings are set for strong expansion in the coming years. Stanley is well worth a look for value and growth investors alike. Here are three reasons why.
Earnings headwinds will dissipate
As CEO Jim Loree outlined during the recent earnings call, Stanley has suffered "significant external headwinds caused by tariffs, cost inflation, and FX [foreign exchange] pressures, all totaling approximately $1 billion of unfavorable margin impact" and acting in the 2018-2020 period. To put this figure into context, Stanley's earnings before interest, taxation, depreciation and amortization was $2.5 billion in 2019.
Stanley Black & Decker is benefiting from a surge in interest in DIY due to stay-at-home measures. Image source: Getty Images.
There's no guarantee these headwinds will completely disappear, but when discussing 2021 on the recent earnings call Loree said, "Perhaps most refreshing of all is the absence of sizable new headwinds in the area of FX, inflation and tariffs." A lack of new headwinds would set Stanley up for good profit growth in the future.
Cost cuts have improved underlying margin
It's been a difficult few years for the company in terms of external cost pressures, but management has been extremely proactive in cutting costs and implementing controls. The main benefit of that is Stanley will be a leaner company in the future, capable of converting revenue growth into significant profit growth.
Indeed, the improvements in operating margin can already be seen in the third-quarter performance.
| Metric |
Third Quarter 2020 |
Third Quarter 2019 |
|---|---|---|
|
Revenue |
$3.85 billion |
$3.63 billion |
|
Gross profit |
$1.38 billion |
$1.24 billion |
|
Gross profit margin |
35.9% |
34.3% |
|
Adjusted operating profit |
$680 million |
$526 million |
|
Adjusted operating profit margin |
17.7% |
14.5% |
Data source: Stanley Black & Decker.
Moreover, the margin performance is even more impressive when considering that the security and industrial segments saw revenue declines in the quarter due to the impact of the pandemic. The real star of the show was the tools and storage segment, which generated substantial margin expansion alongside 11% revenue growth driven by DIY activity during lockdowns.
| Segment |
Q3 Revenue |
YOY Organic Growth |
Segment Profit |
YOY Change |
Operating Profit Margin |
YOY Change |
|---|---|---|---|---|---|---|
|
Tools and storage |
$2.8 billion |
11% |
$603 million |
43% |
21.5% |
490 bps |
|
Industrial |
$587 million |
(7%) |
$72 million |
(24%) |
12.3% |
(270 bps) |
|
Security |
$460 million |
(1%) |
50 |
(1%) |
11% |
10 bps |
|
Total |
$3.85 billion |
6% |
$725 million |
28% |
17.7% |
320 bps |
Data source: Stanley Black & Decker. YOY = year over year. BP = basis points.
Focusing on the tools and storage segment, CFO Don Allan said that the strong increase in profits came down to "excellent operating leverage due to the significant adjustments to our cost base over the last six months in response to the pandemic."
Furthermore, Allan thinks the margin improvement will stick, and described the tools and storage segment as now being a "very high-teens margin business" with expectations for 18% to 20% margin for the segment in 2021.
Significant growth prospects
Stanley a story of potential margin expansion due to cost cuts and headwinds dissipating, and it's also one of plenty of exciting growth prospects, too.
In the near-term, the industrial and security segments are likely to see a bounce in revenue next year as they recover from 2020. To this end, Allan outlined that around a quarter of Stanley's portfolio (mainly in the industrial segment) had declined double-digits in 2020 with another 20% (industrial segment, security segment and tools in emerging markets) "showing modest retractions."
Clearly, there's an opportunity for industrial sales to bounce as the economy improves as demand for fasteners picks up and auto systems sales increase in line with car production ramps from 2020. In addition, the pandemic appears to have created new growth opportunities within health and safety and management is investing in initiatives like facility controls and touchless stores to take advantage of it. Both segments are expected to grow in 2020.
Finally, the tools and storage segment has a host of growth opportunities which have, arguably, been enhanced by the stay-at-home measures boosting DIY activity:
- The Craftsman brand (a DIY tools brand bought from Sears Holdings in 2017) is a major beneficiary of the pandemic and is approaching $1 billion in revenue -- some six years ahead of the initial plan.
- Within tools, Stanley is the clear market leader in e-commerce (three times bigger than its nearest competitor) and the company continues to benefit from the shift toward online purchasing.
- The DEWALT brand should see the benefit of a return to industrial/construction activity in 2021.
- Stanley has an option to buy the remaining 80% share in MTD (lawn and garden products), giving it an exciting opportunity to take advantage of the pandemic-induced trend toward home improvement.
A stock to buy?
Stanley is a business with mid-single-digit revenue growth prospects and significant margin expansion opportunities. As such, Wall Street analysts have the company generating $9.49 in earnings per share and $1.6 billion in free cash flow 2021. These figures imply a price-to-earnings ratio of 19 times earnings and 18 times free cash flow. That's a good value for a company with excellent growth opportunities.
