In early February, Stanley Black & Decker (SWK -0.62%) reported its fourth-quarter and full-year earnings, and updated investors about its capital allocation strategy and cost-cutting plans. Investors are looking for answers, given the stock's historic collapse from the all-time high it reached in 2021 to the 8-year low it touched in late 2022.
Here's what's going on with the industrial tools maker, the status of its dividend, and what to look for in 2023.
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Stanley Black & Decker goes from tailwinds to headwinds
Stanley Black & Decker has a long history of stability and reliability that rewards shareholders through a growing dividend. The company owns well-known brands such as Stanley, Black & Decker, DeWalt, Craftsman, Irwin, and Lenox. With 55 consecutive years of dividend raises, Stanley Black & Decker is a Dividend King, one of only a few dozen companies that have paid and raised their dividends annually for at least 50 consecutive years.
Like most companies, Stanley Black & Decker was blindsided by the COVID-19 pandemic. But with folks stuck inside, the company ended up experiencing a surge in sales as more people took up home improvement projects. The spike proved ephemeral. And in hindsight, it's clear that all it did was pull forward sales that would have come in future years.
The eventual result of that sales spike left Stanley Black & Decker with too much inventory on hand. The company has been scrambling to catch up with market trends and has done a poor job managing its supply chain and inflation-related costs. Its gross margins have collapsed to 10-year lows, its profits have evaporated, and the company is just now returning to positive free cash flow (FCF). The following chart sums up why Stanley Black & Decker is in dire straits.
SWK Inventories (Quarterly) data by YCharts.
The company implemented multibillion-dollar cost-cutting programs and turned its attention to boosting profits and growing FCF. It's the right decision, but it will also involve moving inventory at a discount, which will compress profit margins in the short term. Stanley Black & Decker is dealing with the fact that it overestimated the persistence of higher consumer demand. Now it is paying the price.
Ongoing challenges for Stanley Black & Decker
Stanley Black & Decker's 2023 forecast points to more pain ahead. On a GAAP basis, the company is guiding for earnings per share (EPS) in the range of negative $1.65 to positive $0.85, and between $0 and $2 EPS on an adjusted basis. It's also guiding for $500 million to $1 billion in FCF -- which is in the range of its pre-pandemic FCF levels. It plans to get its gross margin back to 35% over time. In 2022, Stanley Black & Decker blamed 6 to 7 percentage points of gross margin loss on production curtailments and its efforts to destock high-cost inventory. Investors shouldn't expect gross margins to improve to pre-pandemic levels until the company has completed its cost-cutting measures and reduced its inventory to normal levels.
Given the state of the business and management's 2023 guidance, the company simply doesn't have the cash to be buying back its own shares or implementing large dividend hikes. That's a disadvantage since the stock is down so far. Companies that generate tons of FCF -- like Apple, for example -- have the flexibility to buy back their own stock when it gets beaten down. The issue for Stanley Black & Decker is that it paid $471 million in dividends in 2022. But since the company only expects to make $500 million to $1 billion in FCF in 2023, it doesn't have enough dry powder to buy back stock. Not to mention the company should probably use a portion of its FCF to pay down debt.
A smart long-term decision
One of the most important points from the Q4 2022 earnings call was management's commentary on the dividend. Stanley Black & Decker CEO, Donald Allan, said this in response to an analyst's question:
The dividend continues to be a very important part of our capital allocation strategy. We believe that it's a necessary thing for us to maintain the level of the dividend that we have today. We'll continue to evaluate that through the remainder of the year, but there's no change in that strategy at this stage. Obviously, buying back stock is not an opportunity for us, given the leverage we have on our balance sheet. And so therefore, returning value back to our shareholders, the main lever we have today is our dividend.
The company is making a prudent decision to rule out buybacks. And while management is saying it is only going to maintain the current dividend, I would expect a minimal increase to sustain the company's Dividend King status -- even if it is just a penny per share per quarter.
3M, another industrial Dividend King that is having business troubles, paid a $1.47 per share quarterly dividend in 2020, $1.48 per share per quarter in 2021, $1.49 per share per quarter in 2022, and just announced an increase to $1.50 per share for Q1 2023. Such negligible raises do little to boost shareholder value. But Dividend Kings are protective of their track records given that steadily growing payouts are core parts of their investment theses.
Stanley Black & Decker stock is a buy
As much as shareholders want to see sizable dividend hikes, it is better for a struggling business not to spend a lot of money on dividends and instead use its funds to get back on track -- whether that's through improving operations, improving the balance sheet, or both. In the case of Stanley Black & Decker, management is making a smart decision to curb investor enthusiasm by setting low expectations for 2023 performance, the dividend, and buybacks.
The company's turnaround will take some time. But given that its inventories have already started to fall and margins are set to begin rebounding, the worst could be over for Stanley Black & Decker. With the stock trading near a multiyear low and the dividend yield at 3.7%, now could be a good time to consider picking up shares of the tool titan.
