Saturday, November 9, 2013

Stanley Black & Decker is Still Not Cheap Enough

The latest results from Stanley Black & Decker (NYSE: SWK  ) probably left investors feeling they had been hit by one if its power tools. The company lowered full-year earnings-per-share guidance by more than 10% to $4.90-$5.00, causing the market to immediately punish the company by selling its' shares off by more than 14%. Has the market overreacted, making right now the ideal time to step in and buy? 

Stanley Black & Decker disappointsTo understand what happened, you must go back to the company's strategic growth plan outlined earlier in the year. In brief, the idea was to generate an extra $850 million in run rate within three years.

Source: Investor Relations Presentations

Fast forward to the last set of results, and the company was forced to reduce earnings and free cash flow guidance. Essentially, it blamed half of the earnings- guidance reduction on slower-than-expected margin improvements in the security market (particularly in Europe), and lower growth expectations in its construction do-it-yourself and industrial markets. The latter two divisions saw weakness due to a slowdown in emerging markets, and the effects of the US government sequestration and shutdown.

Emerging market and government weakness temporary?Eagle-eyed readers will note that the weak spots are in areas that are key elements of the strategic growth initiative. Moreover, the weakness in the emerging markets is especially worrying because the company is planning to generate great leverage out of a relatively low level of plant investment.

One of the ideas behind its 'mid-price-point growth  program' for 2014 is to start to compete with more moderately priced products, because traditionally it sold to the top 10%-20% of the market within the emerging markets. On the conference call, management declared that they felt the emerging market slowdown was:

 "..a slight temporary deceleration, we believe, associated with some macroeconomic pressures we are seeing in these geographies."-Quarterly Conference Call

And for these reasons, the company is not going to make any significant adjustment to its emerging market plans. All told, if the weakness in emerging markets turns out to be lasting, then the company is likely to disappoint next year with a key element of its growth plan.

Two of the key companies to follow in this regardare Whirlpool (NYSE: WHR  ) and General Electric's (NYSE: GE  ) home & business segment which contains its household appliances segment. GE recently reported an impressive 7% growth in revenue for this segment, with household appliances rising 11%. GE and Whirlpool are both interesting, because we are approaching the 10 year anniversary of the peak years of the US housing bubble. In other words, many of the appliances that GE and Whirlpool then will enter their replacement cycles.

Indeed, in its third-quarter outlook, Whirlpool upgraded its North American growth expectations for the full-year, but lowered guidance for Asia, and Latin America. This is the second quarter in a row that Whirlpool has done this. Interestingly, Whirlpool raised guidance for its European region.

Full Year Industry Demand Assumptions Q1 Outlook Q2 Outlook Current Outlook
North America 2% to 3% 6% to 8% 9%
Europe, Middle East & Africa Flat Flat to -2% Flat
Latin America 3% to 5% 1% to 3% 1%
Asia 3% to 5% Flat -2%

source: Investor Relation Presentations

Whirlpool raised its full year EPS guidance, but this is mainly due to relatively better performance within developed markets, and particularly North America. Moreover, Whirlpool only generates 4.2% of current sales from its Asia region compared to 55% from North America.

Turning back to Stanley Black & Decker, its difficulties in the public sector couldn't have been unexpected, and they may prove temporary, but it does call into question the future plan to generate $100 million in run rate from the US Government.

No security in security for Stanley Black & DeckerHowever, the deeper concern must be with the slowness of margin expansion in the security division. The problems appear to relate to its acquisition of Swedish security company Niscayah. On the conference call, management outlined three structural issues with regards the integration

  • Management underestimated the extent on which Niscayah relied on referrals from its previous parent company Securitas

  • Niscayah's senior management team left, and Stanley Black & Decker was forced to replace them and rebuild a sales force

  • Niscayah previously had a 'legacy systems integration' rather than the kind of recurring revenue model favored by its US acquirer, and changing it takes time

In short, these issues are slowing the pace of margin improvements in security. It's easy to hear about problems in Europe and quickly conclude that they are macro-related, but note that these issues appear to be company specific. In other words, if Stanley Black & Decker can resolve them internally, then there should be upside to come.

The bottom lineFrankly, I think investors should give the company the benefit of the doubt over the emerging market and US government issues because they may well be temporary. In any case, company expectations have now been lowered so any resolution of these 'temporary' issues should now offer upside potential. However, since much of growth depends on the emerging markets, investors have a right to be concerned. Whirlpool may be a better option for investors looking to avoid emerging market uncertainty.

Stanley Black & Decker's management outlined that it now expects 3% to 4% organic growth in the second half compared to expectations for 6% previously. Free cash flow guidance for 2013 was cut by 20% to $800 million. In addition, for 2014 the management discussed 4% to 6% in organic revenue growth, and a conservative looking 7% to 9% in earnings growth.
Cautious investors may well wait to see evidence of improvements with the Niscayah acquisition before jumping in. To be fair, this is a management versed in integrating companies, but on a forward P/E of more than 15 times, this stock is unlikely to be bought by people attracted to its current single-digit earnings forecast.

No comments:

Post a Comment