It wasn't a happy earnings season for Stanley Black & Decker (SWK -1.59%) investors. While it's fair to say the company's significant full-year guidance cut wasn't exactly a surprise -- Stanley is well known in the market as being susceptible to rising raw material costs -- the extent of the cut still surprised investors.
That said, the market looks like it has overreacted, and the stock is looking a great value now. Here's why.
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What happened
Focusing on full-year 2022 guidance, here's a look at how management downgraded expectations at the end of April:
- Full-year adjusted earnings per share (EPS) guidance of $9.50 to $10.50, compared to prior guidance of $12 to $12.50.
- Full-year free cash flow (FCF) of approximately $1 billion to $1.5 billion, compared to about $2 billion prior guidance.
These are significant cuts to guidance. However, some context is needed. For example, based on the midpoints of the new guidance, Stanley trades on some attractive valuations. At the current price of $121 and a market cap of $18.3 billion, Stanley's full-year 2022 price-to-earnings ratio is just 12 times earnings, and its price-to-FCF multiple is just 14.6 times FCF. These are attractive multiples for a business with long-term growth prospects.
Why management lowered guidance
Moreover, there's reason to believe Stanley can recover from the setback. The midpoint of EPS guidance was lowered by $2.25 from $12.25 to $10. The $2.25 reduction breaks down like so:
- $0.30 comes from the reduction in earnings due to a divestiture.
- $0.15 is due to the closure of its business in Russia.
- $3.50 is from commodity and transport cost inflation.
- A $1.70 positive contribution from increased pricing and other actions.
The most worrying item is commodity and transport cost inflation. CFO Don Allan discussed the matter on the earnings call, saying that there is now a $600 million incremental cost expectation due to "significant increases in battery inputs such as lithium, nickel and cobalt, oil-related inputs such as transport and resins, and continued upward movements in other base metals and steel."
Management is implementing price increases in response, such as the aforementioned $1.70 in EPS contribution. Furthermore, Allan's guidance on cost increases may prove conservative, as he "assumes these spot prices stay in place for the remainder of the year going into next year."
Of course, if prices of these commodities moderate, Stanley could see some upside to earnings expectations. In addition, the company's underlying growth prospects remain.
Four other reasons the company can grow
First, management can continue developing its powerful tool brands (Stanley, DeWalt, Craftsman, and Black & Decker) as it consolidates the power tool market.
Second, with the recently announced sale of its automatic doors business to Allegion for $900 million in cash, Stanley has completed the divestment of its former security business (a $3.2 billion deal to sell most of the security business to Securitas was announced in December). Therefore, the company is now focused on its core businesses.
Third, the core businesses now include a leading position in the outdoor power equipment following its purchase of the remaining share of MTD (lawn and garden equipment) in 2021. It's a complimentary deal to Stanley's existing outdoor products business, and CEO Jim Loree believes that "our outdoor business is now a powerful growth engine with approximately $4 billion-plus in annual revenue" and is "capable of growing 10% to 15% organically at mid-teens operating margin for many years to come."
Image source: Getty Images.
Fourth, Stanley's industrial business ($647 million in first-quarter sales compared to the tools & outdoor segment's $3.8 million) sees heavy exposure to the aerospace and automotive markets. As they recover over time, Loree sees "a $300 million to $400 million multiyear growth opportunity with accompanying margins returning to the mid-to-high teens over time." For reference, the industrial segment's margin was just 6.9% in the first quarter.
A stock to buy
All told, given a moderation in commodity prices and an absence of market share and sales volume erosion in response to its price hikes -- something to look out for -- there's a strong case to be made for buying the stock. Those conditions could see Stanley outperform its lowered earnings and FCF expectations.
Furthermore, investors should really focus on the long-term development of the business (outdoor power equipment, multiyear recovery in the industrial segment, power tools growth, etc.) rather than pricing in assumptions of never-ending cost inflation.
Cautious investors may want to see hard evidence of a decline in Stanley's key commodity costs and proof of market share retention before buying in. Still, more aggressive investors may want to buy in now.
