Nobody said investing was easy. You might imagine tool maker Stanley Black & Decker (SWK 0.36%) would be one of the easiest companies to analyze. However, thanks to a bewildering range of cost headwinds in the last few years it hasn't always been easy to see the underlying picture. Throw in the COVID-19 pandemic, and it's even more confusing. But bear with me, because I'm going to try to sift through the weeds in outlining why the stock deserves a close look for long-term investors.
External cost headwinds
The first place to start is with the $1 billion worth of external cost headwinds that the company suffered over the 2018-2020 period. To be fair, all companies are prone to suffering some sort of cost headwind in any given year, but a combination of unfavorable exchange rate movements, tariff costs, and raw material costs hit the company in a big way over a three-year period.
Image source: Getty Images.
The chart below shows how cost of goods rose in the period, and even though revenue increased it wasn't enough to offset the pressure on margin from rising costs. Consequently, gross margin fell as revenue moved up through 2018-2020.
Data by YCharts
The key question then is whether to accept the earnings numbers generated over the period as indicative of the company's future earnings potential, or to make some allowance for it. I'll come back to this point later.
What happened in 2020
Matters get even more confusing when looking at 2020. No one needs reminding that the pandemic spread out of China in March, and Stanley's sales got hit along with most other businesses in March and April. However, the stay-at-home measures produced a surge of interest in DIY and home improvement.
According to CEO Jim Loree on the recent earnings call, Stanley "enjoyed a surge in North American retail of a magnitude never before experienced" from the end of April through the summer months. That trend extended into Europe, and Stanley found itself having to expand capacity to keep up with demand. The chart below shows how quarterly sales progressed through 2020.
Data by YCharts
Again, this highly unusual trend in sales leads to questions around what kind of growth rate to expect in the future. For example, Stanley's sales increased by 16% on an organic basis in the fourth quarter led by a whopping 25% increase in its tools and storage segment sales during the quarter.
What's happening in 2021 and beyond
Turning to management's planning assumptions for 2021, it's clear that it will be a tale of two halves. The impressive momentum of the fourth quarter is seen as carrying through into the first quarter, and then the company comes into an easy comparison with the second quarter of 2020. After that the comparison gets very difficult, and management is actually expecting a year-over-year sales decline in the second half. See what I mean by confusing?
|
Management Assumptions |
First Quarter |
First Half |
Second Half |
Full Year |
|---|---|---|---|---|
|
YOY organic sales growth |
21%-26% |
27%-32% |
(12%)-(7%) |
4%-8% |
Data source: Stanley Black & Decker. YOY = year over year.
Moreover, what about long-term growth prospects? Loree sees the explosion of interest in DIY as creating a "secular shift" in demand, and said: "I think the home center CEOs would agree with that. I've heard them talk about that as well. So that's a big deal."
How to think about Stanley Black & Decker
When all is said and done, perhaps the best way to think about the company is to ignore the noise around the headwinds in the previous years and the expected sales decline in the second half, and focus on the long-term instead. At the same time, that shouldn't involve being too optimistic over some sort of secular shift toward DIY.
Stanley Black & Decker is a major beneficiary of the surge in interest in home improvement. Image source: Getty Images.
A compromise approach would be to accept management's 2021 forecast for full year EPS of $9.70-$10.30 and free cash flow (FCF) equivalent to net income, and then use that as a ground zero assumption from which organic sales are likely to grow in the of 4%-6% range. The last figure is in line with management's long-term objectives as laid out in its investor day in 2019.
Based on these estimates, Wall Street analysts are forecasting $10 in EPS and $1.5 billion in FCF for 2021, putting Stanley on 19 times FCF and 18 times earnings. That's a good valuation for a company with mid-single-digit revenue growth prospects. Throw in some acquisition-led growth opportunities and Stanley is an attractive stock for long-term investors.
