It wasn't a surprise to see Stanley Black & Decker (SWK 1.92%) cut full-year earnings -- there's no shortage of signs of weakening consumer spending -- but the magnitude of it was a shocker. Having started the year with management forecasting adjusted EPS of $12-$12.50 (reduced to $9.50-$10.50 in April), investors are now looking at just $5-$6. The markets punish such downgrades, and the stock is down more than 48% in 2022. So what's going wrong, what questions does management have to answer, and is the stock worth buying now?
NYSE: SWK
Key Data Points
What was supposed to happen
This was supposed to be the year when Stanley built on the burgeoning DIY tools sales built up during the pandemic while integrating its acquisition of MTD (lawn mowers, snow blowers, and outdoor power equipment). Meanwhile, refocusing on its core tools and industrial (engineered fasteners) after selling various non-core businesses (electronic security business to Securitas for $3.2 billion, the automatic doors business to Allegion for $900 million, the oil and gas pipeline business to Pipeline Technique) should have enabled management to plan for increased profitability in the coming years. Moreover, management was expecting its profit margin to increase through the yearas raw material and logistics costs eased.
What really happened
Unfortunately, events took a different turn.
- Persistent commodity and cost inflation was more than expected
- The closure of business in Russia shaved some earnings
- According to CEO Don Allan on the earnings call, rising interest rates and pressure on consumer discretionary spending led to "slower demand trends in June" in its DIY tools business
- Allan also noted that the "very late start to the Outdoor season due to weather resulted in significant volume pressure versus expectations and revenue."
As a result, instead of a mid-to-high-single-digit increase in tools & outdoor full-year organic sales, management now expects a mid-to-high-single-digit decline, with margins decreasing. It gets worse. The industrial business (nearly 14% of segmental sales in the second quarter) is expected to experience a margin decline in 2022.
The guidance cut and what management is doing about it
I've replicated the figures from management's presentation so you can see where the guidance reduction from the first quarter's adjusted EPS estimate came from.
Management launched a series of measures to reduce inventory (an issue when sales drop off), reduce indirect spending, reduce the complexity of its business (organizational layers will be cut from 12 to seven or eight), and restructure its supply chain.
Regarding the last element, Allan said Stanley's current long supply chain is "not matched well with the short cycle nature of our businesses" and "we believe being closer to the customer is the right answer." Investors are entitled to wonder why this conclusion wasn't reached earlier, or at least before former CEO Jim Loree departed in June, leaving guidance significantly higher than it is now.
|
Element |
Adjusted Diluted EPS Guidance Factors |
|---|---|
|
April guidance |
$9.50-$10.50 |
|
Lower expected revenue in the second half |
($4.25) |
|
Adverse currency, second quarter performance, and other items |
($0.55) |
|
Plant production curtailments |
($0.70)-($0.50) |
|
The positive impact of cost-saving initiatives |
$0.80 to $1 |
|
Current guidance |
$5-$6 |
Data source: Stanley Black & Decker presentations.
The cost savings plan
Allan and interim CFO Corbin Walburger outlined Stanley's plan to cut costs. They see annual costs cut by some $1 billion by the end of 2023, with $150 million to $200 million in the second half of 2022. Of the $1 billion in annual cost savings by 2023, $500 million will come from the supply chain transformation, and the other $500 million from simplifying corporate structure ($200 million), cutting indirect spending ($200 million), and finally cutting organizational layers ($100 million).
Furthermore, management sees an opportunity to achieve a further $1 billion reduction in supply chain transformation costs within three years. In total, it comes to $2 billion in cost savings within three years.
Management plans to use the cash, where possible, to "further accelerate investment" in its commercial programs (innovating in power tools, investing in outdoor power equipment, auto fastening solutions for equipment for electric vehicle manufacturers, and investment in digital marketing).
Is the stock a good value?
Ultimately, management sees a path to around $7.25 in adjusted diluted EPS by 2023, with Walburger arguing that annualizing the $3 in EPS forecast for the second half of 2022 and then adding the cost savings planned for 2023 would get you to around that figure.
Suppose you pencil in the $7.25 in EPS for 2023. In that case, the stock trades on a price-to-earnings ratio of 13.4 times 2023 earnings, with another $1 billion in cost savings and underlying margin expansion as volumes improve from a low base.
It's a compelling proposition, but it will take at least a few quarters before management restores lost credibility with investors. The bulls will believe this was a "kitchen sink" quarter where Allan decided to reset expectations as he starts his tenure as CEO. At the same time, the bears will worry about more guidance cuts if Stanley finds it hard to generate sales and reduce inventory.
