Description

Background

Stanley Black and Decker is a leadging global manufacturer of hand, power and outdoor tools that sell under the brands Craftsman, DeWalt, Stanley and Black and Decker. They also own an industrial business that is focused on engineered fastening and infrastructure construction equipment.

SWK's tool segment is about 70% US based and is sold in home-centers like Lowe's, Home Depot, Ace Hardware and online channels like Amazon but are also also distributed to pro customers through other distribution channels.

In late 2021, SWK simplified their business model after they sold Stanley security to Allegion to reduce debt that had become elevated after they purchased outdoor products manufacturer MTD.

2022 was a very challenging year for SWK for several reasons:

1) Tool demand went from a pre-COVID surge where home-centers and distributors were crying for inventory to a post-COVID slump where home centers were grossly overstocked on SWK product. SWK also made the mistake of chasing the demand curve and over produced inventory in anticipation that demand would hold. This led SWK to enter into an extended de-stocking phase which I believe is coming to an end in 2Q or 3Q at the latest.

2) SWK acquired MTD at the peak of the outdoor market and faced a challenging integration as demand evaporated, exacerbating margins for SWK's tools division.

3) SWK is paying today for poor execution of the prior CEO (Jim Loree) post the Craftsman acquisition. In short, SWK integrated all the brands poorly and ended up with too much overlapping product among all it's brands, which contributed to it's current inventory problem.

Thesis

As a result, Tools EBIT margins went from a pre-COVID 15-16% down to 9% in 2022 and for parts of 2023. While the end to SWK's earnings declines aren't imminent, as they probably need to guide 2023 EPS to low-4's. That said, the stock is down 60% from it's 2021 peak and when demand normalizes, a $7-handle EPS is quite likely in 2024, which is 30% below 2021 peak-COVID earnings.

The reasons why I think they can get there is the new CEO, Don Allen has laid out a plan to de-stock, simplify SKUs and enter the next cycle with a cleaner porfolio and a goal to get back to mid-teens margins in 2H23 into 2024. Below is a slide from their 3Q22 call which lays out the trajectory of the gross margin compression and exit and excludes cost savings from supply chain improvements and selling synergies from a simplified SKU universe.

On the plus side, with this de-stocking, SWK is expected to release $2.5bn in working capital which they will use to reduce debt and repurchase shares, which is almost 10% of shares outstanding if just 50% went to buybacks.

Risks

Timing is the biggest risk to the thesis where demand in December appeared to worsen vs Nov which may kick the gross margin trough out to 1Q-2Q23 leading to a low $4 EPS for 2023, but the rebound will come and tools is essentially a duopoly making historical margins low hanging fruit (Techtronics being the largest competitor globally with a 33% market share compared to SWK's 25%).

Valuation

Between 2016 through 2019, SWK traded between 17-20x P/E for a relatively stable and profitable business with high teens margins even in the face of intense trade wars and a poorply placed China manufacturing footprint. If you have a long enough view to underwrite $7.15 EPS in 2024 and a 17x multiple, it's not hard to a get to a $125 price target, 40% from here.

$7.25 in 2024 is bsaed on $14bn in tools revenue, which is 3% above 2019 levels (pro forma for MTD), which isn't a herculean assumption and EBIT margins at 15.5%.

Catalyst

Timing is the hard part and waiting for the de-stocking to bottom is the catalyst, but once the line of sight becomes clear, I believe investors will be more willing to underwrite 2024 EPS.