Torrid Tool Demand Continues To Drive Stanley Black & Decker

With people stuck at home and using that time to fix up their houses, not to mention past strategic initiatives bearing fruit, Stanley Black & Decker (SWK) has enjoyed some exceptional growth lately in its core Tools & Storage business. Although the comps are going to get tougher, acquiring the reminder of MTD creates some longer-term, if controversial, growth and leverage opportunities, and 2021 should see some improvement in the Industrial Security businesses.

I last wrote on Stanley Black & Decker ("Stanley" from here on) in September, and at that time I thought it looked like an interesting relative value call in the industrial space. The stock has been a mediocre performer since then, doing a little better than the S&P but no better than the broader industrial group, due to what I believe may be some concerns about the durability of the growth seen in 2H'20 and rotation to other themes.

I do still find the valuation to be interesting on a relative basis, but I am concerned about sentiment given the likelihood of slowdowns in the residential and non-residential markets, as well as some ongoing risks to capex spending in oil/gas and commodity price inflation. At this point, I personally still lean positive on the shares as a longer-term holding.

 

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Torrid Tool Demand Continues To Drive Stanley Black & Decker

Stanley Black & Decker Looks Poised To Outperform Its Industrial Peers

There's a lot going on at Stanley Black & Decker (SWK). Meaningful improvements to the business and a strong remodel/renovation market have supported healthier trends in Tools & Storage, while the sudden, sharp decline in auto builds has made life difficult in that business, and management still doesn't seem to have made up its mind on the Security business. On top of that, the company has launched an aggressive cost reduction program, with a prominent place given to automation, and management seems keen to pursue reshoring.

When I last wrote about Stanley Black & Decker, I wasn't inclined to chase and thought there would be opportunities to buy on dips. I certainly wasn't expecting the crater that was to come with the COVID-19 panic, but the shares have done a little better overall than the average industrial since that last piece. While Stanley Black & Decker is not as cheap as I'd like, I do like the momentum in this business and the possibility of both above-average growth and margins after a period of underperformance.

 

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Stanley Black & Decker Looks Poised To Outperform Its Industrial Peers

Stanley Black & Decker Comes In A Little Light, But Has Drivers For 2020

The last year has been fairly good for Stanley Black & Decker (SWK) despite significant headwinds from tariffs, the U.S. dollar, and challenging conditions in the auto end-market. Helped by growth in the tools business, Stanley Black & Decker’s organic growth held up better than most multi-industrials, and there has been further progress in the Security business.

When I last wrote about the stock, I recommended picking up SWK shares if and when they fell below $140. Investors got two of those opportunities, and the shares have solidly outperformed the industrial sector and the S&P 500 since the last one. At this point, even with what is likely to be an above-average organic growth profile for 2020, I think the shares are little pricier and I’d be more interested again in the $150’s.

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Stanley Black & Decker Comes In A Little Light, But Has Drivers For 2020

Stronger Margins A Welcome Surprise From Stanley Black & Decker

There’s no “just one thing” that matters above all else when it comes to industrial companies and market valuations, but margins count for a lot. That makes Stanley Black & Decker’s (SWK) surprisingly strong second quarter margin performance all the more welcome, and particularly so with the company recently outlining a path to meaningful further margin improvement over the next three years.

Weaker end-markets remain a risk for the remainder of 2019, and management’s guidance seems a little conservative relative to the performance seen in the second quarter, but Stanley Black & Decker seems to be on better footing and with drivers still yet to materialize (expanding the distribution channels for Craftsman, for instance). The shares aren’t all that cheap now, but on another dip below $140, it would definitely be a name to consider.

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Stronger Margins A Welcome Surprise From Stanley Black & Decker

Stanley Black & Decker Comes Back With A Stronger Report

A weak, and poorly-received, fourth quarter put Stanley Black & Decker (SWK) in a hole, and while the shares have lagged industrial peers over the last year, the performance since my last update has been noticeably better. With a strong first quarter driven in very large part by the tool business, Stanley’s guidance for 2019 certainly looks more attainable than just three months ago. While I still see risks in the second half of the year from weaker than expected “general industrial” markets, Stanley should be poised to benefit from gradual improvement in auto demand later this year and some self-directed gross margin improvement efforts.

I’m not as interested in the valuation/share price opportunity as I was in January, as the stock has risen more than 20% since then (roughly doubling its peer group). I’m concerned that the market and industrials in particular are ahead of themselves now and I’d prefer to wait for a better entry price before starting a position here.

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Stanley Black & Decker Comes Back With A Stronger Report

A Sharp Downturn In China Seizing Up Nidec's Growth Engine

Evidence continues to mount that conditions in China, and to a lesser extent other regions around the world, are not good. Nidec (OTCPK:NJDCY) (6594.T) has seen a withering decline in auto business in the last couple of quarters, with weakness spreading beyond autos into consumer appliances and various industrial markets. At the same time, though, Nidec continues to build for its future – globalizing its production capabilities and logging significant inquiries for its electric vehicle traction motors.

Nidec isn’t quite as cheap as I might wish, and I think this macro malaise could linger on a little while longer than the Street presently expects, but I think this is a very good company now trading at a reasonable valuation. In addition to a major opportunity in EV motors, I believe Nidec is leveraged to ongoing growth in brushless motors, robotics, and data centers, and could deliver meaningful operating leverage with this latest efficiency initiative. Looking past the rocky near-term, I think these shares could be 10% undervalued today and that the shares could re-rate meaningfully higher as 2019 moves on if and when the outlook for China improves.

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A Sharp Downturn In China Seizing Up Nidec's Growth Engine

Stanley Black & Decker's Guidance Doesn't Bode Well For Industrials

Seen by many investors and analysts as a relatively safer play in industrials for 2019, Stanley Black & Decker (SWK) was hammered (down 15%) after reporting earnings, as investors saw more than a few alarming items in the company’s guidance pertaining to some major industrial end-markets. Given the acknowledgement of weakening conditions in key markets like autos and residential housing, not to mention some limits on pricing amid ongoing cost pressure, I expect investors are going to be paying much closer attention to names like Illinois Tool Works (ITW), Ingersoll-Rand (IR), and 3M (MMM) in this earnings/guidance cycle.

As for Stanley Black & Decker itself, the shares do look undervalued, but the back-end loaded guidance for the year and the margin challenges make it a tough call right now, as there could be at least one more cut to guidance before this is over. I’d also note that Stanley Black & Decker hasn’t exactly been a standout either when it comes to metrics like free cash flow growth, despite ongoing cost reduction efforts.

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Stanley Black & Decker's Guidance Doesn't Bode Well For Industrials

Stanley Black & Decker Still Not Getting Much Benefit Of The Doubt

Between worries about retail demand, construction spending, auto build rates, and input costs (including tariffs), Stanley Black & Decker (SWK) still hasn’t been getting all that much love. This is part and parcel of the challenges of “buying the dip” as I outlined in my prior piece, though Stanley has only modestly underperformed industrials in general over the past three months (though Snap-on (SNA) has been much stronger), the year-to-date performance is still pretty weak and there are valid reasons to worry that management’s guidance for the second half is too aggressive.

I do see some near-term risks, but I think the valuation is pretty interesting. I do believe the Craftsman acquisition creates some interesting opportunities, and I likewise think Stanley has the option to deploy capital into potentially value-enhancing transactions within fastening. Against that “interesting” valuation, though, is the reality that this company’s track record with respect to ROIC and margin improvement are not great and there are execution risks to consider.

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Stanley Black & Decker Still Not Getting Much Benefit Of The Doubt

Emerson Getting A Strong Push From Recovering Process Automation Markets

In a market where many multi-industrials have started to see signs of fading end-market growth, Emerson's (EMR) exposure to process automation, and particularly U.S. onshore oil and gas, is helping the company drive noticeably better growth. Better still, management has been positioning this business to be more competitive outside of its core petrochemical end-markets, while also showing that it is committed to supporting its non-automation business as well.

Valuations have slid back for many multi-industrials, but Emerson has been a relative outperformer this year and doesn't look particularly cheap on a cash flow basis. That said, investors pay up for growth and will pay higher near-term multiples for companies with strong ROICs and Emerson is likely to offer both strong top-line growth and robust ROICs for the near-term.

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Emerson Getting A Strong Push From Recovering Process Automation Markets

Illinois Tool Works's Ability To Drive Growth And Margin Leverage Getting Tested

Even the best-run companies are still subject to the laws of gravity, and valuations got pretty high among the top-tier multi-industrials early this year. Illinois Tool Works (ITW) was one of the more expensive names then, but I’m still surprised that the subsequent correction has seen it underperform some industrial peers like Ingersoll-Rand (IR) and Dover (DOV).

Looking ahead, 2018 is likely to be a year where ITW’s ability to drive organic growth and ongoing margin leverage is going to get tested a little more strenuously. I do have great respect for the quality of ITW’s operations, and its options to grow through M&A, but I do have some concerns that sell-side margin expectations are aggressive. Valuation being what it is, I would lean more toward names like Honeywell (HON) and Eaton (ETN), but if the shares were to fall into the $130s without a significant deterioration in the economic environment, I’d take another look.

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Illinois Tool Works's Ability To Drive Growth And Margin Leverage Getting Tested

Stanley Black & Decker Looks Undervalued, But Growth And Margins Are Decelerating

I've said it many times before and I'll say it again - "buying the dip" sounds like great advice, but it can be tough to follow in practice. Outside of market-wide freak-outs (which still require a certain amount of long-term confidence and patience), those dips often come because of issues that don't necessarily look temporary or quickly solvable at the time. And so it is with Stanley Black & Decker (SWK), as the shares are off about 20% from their January high, but there has been a noticeable slowdown in the business and that second-half recovery is not assured.

I'm a little nervous that I'm expecting too much long-term FCF leverage, and there's definitely meaningful downside risk if Stanley Black & Decker can't improve FCF generation from recent levels, but I don't believe my underlying assumptions are all that aggressive and I believe growth in the Tools and Industrial segments can support a higher fair value than today's price offers.

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Stanley Black & Decker Looks Undervalued, But Growth And Margins Are Decelerating