Is Stanley Black & Decker Stock a Buy?

The market appears to be underestimating the growth potential at Stanley Black & Decker (SWK 0.36%) and the stock represents one of the most compelling investment opportunities in the industrial sector right now. By now, you've probably guessed that the answer to the question in the headline is "yes", so now it's time to flesh out the reasons why.

End markets improving

I last looked at the matter in November ,but since then the company has updated its full-year planning assumptions. In a press release on Dec 16. Management outlined the following changes to its fourth quarter and full-year assumptions given at the end of October.

Data source: Stanley Black & Decker presentations.

Digging into the reasons why growth will be better than previously expected management cited stronger demand in its tools and storage segment with U.S. retail tools and storage point of sales "tracking above the high end of our planning assumption, with the quarter to date growth up 22% through December 5." Stanley has been a beneficiary of the surge in spending on home improvement inspired by stay-at-home measures in 2020.

Moreover, management also cited "stronger performance in Engineered Fastening and Attachment Tools" within its industrial segment. This is a very good sign as it indicates a cyclical recovery in spending from the hard hit manufacturing sector in 2020.

Clearly, the company has good earnings momentum going into 2021 thanks to favorable end market conditions.

The market is underestimating growth prospects

That said, Stanley's bright outlook is not simply a case of its end markets, because the company has been taking significant actions to improve its underlying growth prospects too. The interesting thing is that they come from both the top line (revenue) and the bottom line (earnings) too.

Image source: Getty Images.

For example, management has sought to turn Stanley into the consolidator of choice in the tools industry with the acquisitions of the Craftsman brand from Sears, and the tools business of Newell Brands -- both in 2017. In addition, Stanley has an option to buy the remaining 80% share it doesn't own in MTD (lawn and garden products) as management seeks to expand its outdoor product range. Moreover, the company's early investment in e-commerce means it was ideally placed to benefit from the shift to online purchasing created by the COVID-19 pandemic in 2020.

Turning to the bottom line, aside from the ability to expand margins as sales increase due to benefits of scale, management has also been instigating significant cost actions in order to improve profitability. Meanwhile, the external cost headwinds that have dogged the company in recent years -- tariffs, cost inflation, and unfavorable currency movements -- could be significantly reduced in the coming years.

To put these external cost headwinds into context, CEO Jim Loree estimates that they resulted in "$1 billion of unfavorable margin impact" in 2018-2020 period. For reference, Stanley's operating income is expected to be $5.9 billion over the same period.

Ultimately, Wall Street analysts are expecting revenue growth in mid-single-digit range in the next few years with adjusted operating margin expanding to 16% in 2022 from 13.5% in 2019. These figures imply operating profit of around $2.5 billion in 2022 from around $2 billion in 2020 -- a significant improvement.

Image source: Getty Images.

Valuation matters

Given the company's earnings growth prospects, and its favorable momentum the stock looks undervalued. Stanley current trades on just 18.5 times expected 2021 earnings. That's an attractive valuation for a company with double-digit earnings growth prospects.

In addition, Stanley's long-term strategic aims have received a boost due to the pandemic. In terms of organic growth, the development of the DIY tool Craftsman brand and Stanley's e-commerce initiatives have obviously been helped by the pandemic.

Meanwhile, Stanley also has inorganic growth prospects as its investment in MTD is likely to pay off given the surge in interest in gardening created by the pandemic -- management plans for lawn and garden products to generate 15%-20% of revenue in 2022 from zero in 2018.

A stock to buy

The stock is attractively priced and there's potential for positive earnings surprises in 2021. It's been a difficult few years for the company with external cost headwinds pegging back underlying profit improvements, but investors shouldn't lose sight of the work management has been doing to position the company for growth. Those actions should start to crystallize themselves into significant improvement in the numbers in 2021, leading to stock price appreciation through the year.