Tools and outdoor products manufacturer Stanley Black & Decker (SWK 1.56%) is one of the most intriguing stocks on the market today. Unfortunately, it's down a whopping 55% this year, as just about everything has gone wrong for the company in 2022.
Yet its medium- to long-term prospects look bright, and there's a strong case for buying the stock and riding out the potentially bad near-term news facing the company. In that context, here's a look at the crucial metric investors need to see before feeling fully confident in buying the stock.
What went wrong in 2022
In a nutshell, Stanley was hit with a pincer movement on its margins and profitability in 2022. First, the supply chain and raw-material inflation issues extended far more than expected this year. Instead of a year of easing pressure (leading to margin expansion), cost pressures continued. Second, soaring inflation caused the Federal Reserve to hike interest rates, putting pressure on the housing market and do-it-yourself spending -- hurting Stanley's sales volumes. Throw in poor weather that hit sales of outdoor products (lawnmowers, trimmers, and the like), and it's a perfect storm for the company.
Consequently, operating profit margin in its core tools & outdoor segment declined to 6.8% in the third quarter compared to 15.5% in the same quarter of 2021. And management has cut its full-year adjusted earnings guidance on all three earnings calls in its financial 2022; it now stands at a range of just $4.15 to $4.65, compared to $12 to $12.50 at the start of the year.
What Stanley needs to do now
In response to its difficulties and the need to radically restructure its supply chain to reduce susceptibility to future shocks, management launched a cost-cutting and restructuring plan. The aim is to cut costs by $1 billion by 2023 and by a total of $2 billion in three years.
So the case for buying the stock -- as ably laid out by my fellow Fool Reuben Gregg Brewer -- rests on a combination of successful cost-cutting while the company muddles through a problematic period of reducing inventory amid slow sales growth.
The company needs to increase the speed at which it sells through its inventory -- in other words, its inventory turnover ratio, measured here as revenue divided by inventory. A low inventory turnover ratio implies relatively high inventory levels -- that's bad news because it means cash is tied up in holding inventory. It also suggests that Stanley may have to spend more on marketing or discount prices to reduce inventory, which hurts profitability.
As you can see in the chart below (including two significant competitors, Makita and Milwaukee Electric Tool owner Techtronic), it's a problem across the hardware and tool industry, driven by a deteriorating sales environment. As a reminder, a lower number is worse, as it means a slower rate of generating sales from inventory.
Data by YCharts. TTM = trailing 12 months.
The chart above shows the situation from a trailing-12-month perspective; however, investors should focus on the quarterly figure to see progression in reducing inventory relative to sales.
Data by YCharts
Until Stanley Black & Decker can stabilize this ratio, its profit margins will likely come under threat, which means so will its earnings expectations. That's something that usually puts pressure on the stock price.
A stock to buy?
If you can handle the potential for bad news over the near term, then Stanley might be a stock to buy outright. However, cautious investors will wait for evidence of stabilization in the inventory turnover figure before buying in.
