Description

Background

SWK is a diversified industrial company that is levered to the US housing sector (new construction and repair/remodel) and recoveries in auto and commerical aerospace. They have 3 primary segments, Tools, Industrials and Security.

The Tools business sells hand and power tools through their Craftsman and DeWalt brands that has a significant presence at homecenters and even on Amazon.

The Tools business started off 2020 in a tough spot with significant disruption in their Chinese manufacturing supply chain in 1Q20 followed by a decline in demand in 2Q20 because of COVID leading to -12% sales growth. 2H20 was materially better for Tools primarily driven by DIY/Retail, while industrials/pro within Tools lagged, with growth of 12% YoY to close FY20 +2%.

The industrials businesses compose of fasteners and components sold primarily to auto and aero space end markets. Those markets obviously have had a challenging 2020 but both are expected to recover in 2021 with IHS forecasting 15% growth in 2021 auto growth and Boeing beginning to ramp 737 Max production.

The last segment is security that has historically been cycle resistant. They manufacture, design and sell security systems that typically also involve sliding doors on entry way into buildings.

Thesis

Stanley has been a laggard since early December on several themes / narratives:

1)     Unfairly penalized as a “stay-at-home” name because of its large hand and power tools exposure that has significant DIY exposure through Home Depot, Lowe’s and other retail channels. In a “go-outside” and reflation thematic market, SWK is a perceived loser which I believe is incorrect.

2)     There is a mis-perception that steel and copper inflation will be a significant headwind to 2021 earnings. I believe the headwind will not be as bad as 2018 and SWK has significant cost levers to offset it.

3)     Perception of lapping tough comps in 2021 because of the outsized sales in the home-center channel. I believe that SWK's comps are not as challenging.

I believe that with the 2021 guide on 4Q20 earnings, SWK will alleviate tough-comp concerns and show significant resilience against raw material inflation fears.

2021 Earnings Bridge

I believe that SWK has significant earnings momentum into 2021 with the crystallization of the thesis on the upcoming 4Q20 earnings. There is also a possible accretive deal on the horizon via an option to acquire MTD that I will elaborate on as well. The bridge to my earnings expectation are below:

1)     SWK’s Tools business is more levered to economic recovery than is appreciated.

a.      40% of SWK’s tools business is levered to pro contractors that have been sidelined for most of 2021 because of concerns of contractors in homes - pro contractor backlog as rapidly recovered since October and is set to grow HSD in 2021

b.      30% of SWK’s tools business is levered to industrial end-markets that suffered in 2020. General industrial is expected to recover MSD in 2021.

c.      Tools Segment is set to grow 2% in 2020 (30% of DIY/Retail was +15% vs 70% pro/industrial -4%)

d.      With current DIY/retail trends in January, more stimulus checks on the way and an extremely high level of consumer saving rates, I expect DIY/Retail to remain strong through 2021

e.      Coupled with a recovery in industrial, I think SWK Tools can grow 4-6% in 2021 (8-10% growth in DIY/retail, 4-5% in industrial/pro)

2)     The Industrial segment is 45% levered to auto, 15% to commercial aerospace, 5% to oil & gas and 35% to general industrial

a.      IHS expects America, Europe and China auto manufacturing to grow 15% in 2021

b.      Boeing has begun to resume 737 Max production from 1-2/month to 20/month by mid 2021

c.      Oil & gas rig count has troughed and begun to upswing as confidence in crude is growing after OPEC decisions

3)     Security is a steady grower showing the lest economic sensitivity to bull and bear cycles. I think security will continue to see LSD growth with expanding margins

4)     In 2018, SWK had a trifecta of cost headwinds between steel, China tariffs and FX which amounted to $300m of headwinds ($1.50 of earnings headwinds). SWK was able to offset most of that in cost savings to still grow EPS 9% vs 2017. SWK has significant embedded cost savings to offset inflation.

5)     SWK will have $120m ($0.60 EPS) of carry over cost savings in 2021 from 2020 that should also mitigate raw material inflation.

6)     SWK has begun re-shoring efforts to move 1/3 of their supply chain from China to Dallas, which starts up in 1Q21. SWK expects to get $0.75 of EPS annualized on from not paying Section 301 tariffs – about 1/3 of that will get realized in 2021.

7)     Outdoor power tools - SWK has an option to buy into the outdoor power-tools market (company called MTD) at a fixed accretive multiple at 8x EBITDA vs SWK’s current valuation of 10x. The earliest that SWK can exercise the option is in July 2021. Without going into specifics of the option, SWK can purchase $250m of EBITDA at 8x which would be immediately accretive by $0.40 (not included in my EPS estimate)

I believe SWK will beat their raised 4Q20 guide that was announced mid-December. Their guide did not account for the surge in demand in the last week of December. I also think SWK can guide to $9.75-$10.25.

Valuation

SWK trades at 17x 2021 and 15x 2022 P/E vs a 5-year average of 18x and if SWK exercises the MTD option, SWK would trade PF at 16.5x.

Building product large-caps such as FBHS and MAS trade at 18-19x 2021 EBITDA and multi's and machinery have re-rated recently up to 19-20x.

I think at 18-19x 2022 P/E, pro forma for the MTD acquisition, SWK has a PT of $215 which is 21-28% upside from where it is currently.

The thesis is two-fold, valuation upside via re-rating but primarily under-appreciated earnings momentum in 2021/2022.

Catalyst

SWK 4Q20 earnings. 4Q20 EPS beat and robust guidance for 2021 with likely MSD growth potential and cost savings and re-shoring benefits.
MTD Acquisition. July time-frame catalyst, $0.40 EPS accretive initially. Up to $1.00 accretive by 2023.