Given that Stanley Black & Decker, Inc. (SWK) isn't quite as exposed to a U.S. housing recovery as commonly believed, it isn't the uncertain pace there that is keeping growth down. Rather, Stanley Black & Decker is seeing broad-based sluggishness across almost all of its businesses. While further diversification into industrial fasteners makes some long-term sense and the stock's valuation is not demanding, investors will have to have some patience to see this one work out.
Q2 Results Disappoint On Multiple Fronts
If there was good news in Stanley Black & Decker's second quarter, it was that "core" results weren't quite as weak as the reported numbers appear. Then again, with investors mostly resigned to even worse numbers and guidance (and the stock quite weak over the past month), it ends up looking better than feared.
Revenue rose 8% this quarter as reported, but price and volume were each up only 1%, so the organic rate of growth is clearly much lower. Although the company's Construction and DIY (CDIY) segment reported less than 2% growth, organic revenue growth was more on the order of 5% and the power tools business saw 9% growth. That's considerably better than the results in Security where 29% reported growth masked a single-digit organic decline or in Industrial where revenue rose about 1% on both reported and organic bases.
Due in large part to backing out acquisition-related costs, the company's margin performance was a little bit muddled. If you're willing to go along with backing out the charges, adjusted operating income rose about 11%, with a decent 60bp improvement in operating margin, despite a 60bp drop in adjusted gross margin.
Guidance Looks Bad, But What About The "Core"?
On first blush, Stanley Black & Decker's guidance for the rest of the year is pretty depressing—a $0.35 drop from a range of $5.75-$6.00 to a range of $5.40-$5.65. If there's good news, it's that foreign exchange is playing a meaningful role in the revision. The weakness in Europe (where the company gets about 30% of its business) doesn't appear to be leading to any major changes in outlook, though there are some mix shift issues and the underlying 1%-2% organic growth rate isn't going to excite many people.
Probably Not The Best Housing Play
While it might seem obvious that the company behind Black & Decker, Stanley, and DeWalt tools would be leveraged to a recovery in construction, that's not actually the case. Yes, the company stands to benefit from a recovery in housing and commercial construction, but only about 30% of its business falls into those buckets due to the company's diversification efforts.
Instead, companies like Armstrong World Industries, Inc. (AWI), CaesarStone Sdot-Yam Ltd. (CSTE), Mohawk Industries Inc. (MHK) and Owens Corning (OC) would seem like the better bet for that play. With their strong market leverage to flooring, kitchen countertops, flooring, and insulation, respectively, all of these companies have greater exposure to a U.S. construction recovery than Stanley Black & Decker (60% or more, in fact, except for Caesar Stone).
Will Shuffling The Deck Produce A Better Hand?
For better or worse, management here seems to be unafraid of deals and is actively seeking to diversify further into industrial markets.
Management has acknowledged that it would like to sell the "Hardware and Home Improvement" business—basically the company's door lock and bathroom/plumbing fixtures business. With revenue of over $900 million, this sale could produce as much as $1.5 billion in sales. While these units have held their own against rivals like Ingersoll-Rand plc's (IR) Schlage and Masco Corporation (MAS), they aren't market leaders and they don't have the global platform that management wants.
Selling them as a combined unit may be more difficult, but management already has an idea in mind for the use of those proceeds. In talking about wanting to buy a fasteners business worth $500 million in revenue, they would seem to be confirming their interest in Infastech—a diversified industrial fasteners business. It should be noted though that management made it clear that the two transactions were not contingent (they could and would buy Infastech without an agreement to sell HHI).
While I can appreciate the benefits of diversification (as well as the growth in specialized industrial fasteners), I have to think these announcements are good news for rivals like Emerson Electric Co. (EMR), Snap On Inc. (SNA), and Atlas Copco An Ser A (ATLKY.PK). Empire-building at Stanley Black & Decker may give them more breathing space in their own respective markets like specialty and industrial tools.
The Bottom Line
With Europe gasping, the U.S. housing market still asleep, and industrial end-markets starting to slow, this probably looks like a perfect storm for Stanley Black & Decker. That said, value is value, and I see value here. Provided that the company can get back to mid- to single-digit revenue growth next year and return free cash flow margins to the low teens over the next three to five years, $90 is not an unreasonable target for these shares.