Stanley Black & Decker's (SWK -0.52%) stock has fallen more than 50% over the past year. One reason for that is the company's very weak financial performance in 2022. However, another concern among investors is the company's leverage. Debt is always something that investors need to be aware of, but is Stanley Black & Decker's balance sheet a big issue or not?
Down, a lot
A look at industrial tool maker Stanley Black & Decker's earnings trends over the past year reveals why owning its shares has been less than rewarding recently. In 2021, the company's adjusted earnings totaled $10.48 per share, up 30% year over year. In that earnings update, management projected that 2022 adjusted earnings would be between $12 and $12.50 per share. Fast forward to the third quarter of 2022, however, and the full-year guidance was down to just $4.15 to $4.65 per share, with each quarterly report along the way bringing yet another downward revision.
Image source: Getty Images.
There have been a host of problems to deal with. Inflation has been led to rising costs. Supply chain disruptions have made it difficult to get parts and deliver products to stores. And excess inventories, built up when demand rebounded from 2020 pandemic lows, have to be worked through, leading to reduced production levels (which further increases per unit costs). There's no question that 2022 was a pretty difficult year, and investors have every right to be upset.
As the stock price has gone down dramatically, the yield is up toward historically high levels. Using dividend yield as a rough valuation guide, Stanley Black & Decker's 3.7% yield makes it seem as if the stock has been put on the sale rack. That is, if the company can muddle through the headwinds it faces and get back on track.
The debt problem
Management has plans in place, including cost-cutting and investment in innovation. So it is trying to control the things within its control. Only there's a minor complication that worries investors: The company's debt-to-equity ratio has risen toward historically high levels. At the end of the second quarter, debt spiked to more than 1.2 times equity, higher than it was during the Great Recession.
SWK Debt to Equity Ratio data by YCharts.
The jump was driven by an acquisition, but that doesn't change the fact that Stanley Black & Decker's leverage is extremely high today. Add in the deep drop in earnings and there's a good reason to be concerned. Notably, credit rating agencies downgraded the company's balance sheet in early 2023.
Meanwhile, the company's trailing-12-month times interest earned ratio, another key number, has fallen from over 10 in 2021 to just 2.7 as of the third quarter of 2022. The company is still covering its interest costs (indicated by a number above 1), but it has far less breathing room than before. Investors should be paying attention to the company's balance sheet.
However, you need to keep the risk in perspective. For starters, management is aware of the issue and used recent non-core asset sales to pay down $3.3 billion in debt. That move helped to pull the debt-to-equity ratio from a touch over 1.2 down to about 0.8. That's actually not an unreasonable level at all. For comparison, Emerson Electric (EMR -0.14%) has a debt-to-equity ratio of around 1, and Honeywell (HON -0.70%) comes in at around 0.95 times. So leverage is high compared to Stanley Black & Decker's own history, but it really isn't high on an absolute basis. And that credit agency downgrade still left the company in the investment-grade space, so it was bad news but hardly terrible.
As for the trailing-12-month times interest earned ratio, Stanley Black & Decker is still covering its interest costs. That's a far cry from "zombie" companies that can't even do that much. Given Stanley Black & Decker's efforts to reset its business, notably by reducing production so it can deal with an inventory overhang, there could be further downside on this metric. But given the company's long history of success, punctuated by over five decades of annual dividend increases (it's a highly elite Dividend King), investors should probably give management some leeway before getting too upset.
All in all, leverage is an issue for Stanley Black & Decker, but it isn't as big an issue as some may fear, at least not right now. And, given the recent debt reduction efforts, the trends are improving in important ways.
A dangerous game
Using debt comes with very real risks, so investors should definitely be checking leverage metrics. That's true across the board, not just with Stanley Black & Decker. This industrial tool maker's financial results increase the risk that its historically high leverage could turn into a worrying problem. And yet, given the company's history and the absolute level of the company's leverage, it really isn't worth getting too concerned. Yes, watch the company's balance sheet, but don't get so fixated on it that you miss the upside potential of the steps management is taking to improve business performance -- steps that, if successful, could quickly make leverage a moot point.
