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.
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