Stanley Black & Decker Banking on Buyouts Amid Cost Woes

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On Oct 17, we issued an updated research report on Stanley Black & Decker, Inc.SWK . The company is poised to grow on the back of increased demand for premium brands and meaningful acquisitions. However, rising cost remains a major concern.

Let's delve deeper and analyze the fundamental factors influencing the stock.

Strong Top & Bottom Line Growth Prospects

Stanley Black & Decker's revenues improved 11.7% year over year in 2017 and 5.6% in the first-half of 2018. The company believes that increased popularity of prime branded products (like Lenox and Irwin) and new business contract receipts will continue to drive its top line in the quarters ahead. Moreover, meaningful business acquisitions will aid in sustaining the momentum. For instance, Newell Tools acquisition (March 2017) has significantly aided in strengthening the company's tools business. Meanwhile, Craftsman acquisition (March 2017) has reinforced Stanley Black & Decker's existing global tools and storage brands and created new business opportunities; especially in the lawn and garden end markets. Additionally, Fastener Systems' industrial business acquisition (April 2018) is expected to augment revenues of its Engineered Fastening business going forward. Stanley Black & Decker anticipates securing organic sales growth of roughly 7% in 2018. Notably, the company predicts to generate approximately $22 billion revenues by 2022. Per Zacks estimates, the company's year-over-year revenue growth is currently pegged at 11.4% and 6.4% for 2018 and 2019, respectively.

Stanley Black & Decker has recorded a positive average earnings surprise of 8.93% in the trailing four quarters. The company anticipates stronger revenues, ongoing price realization efforts and diligent cost cutting initiatives to continue to bolster its bottom line. For 2018, the company anticipates to report earnings within the range of $8.30-$8.50 per share in 2018. Notably, its earnings per share are predicted to grow 10-12% by 2022. Per Zacks estimates, the company's year-over-year earnings growth is currently pegged at 12.5% and 11.9% for 2018 and 2019, respectively.

Stanley Black & Decker also remains on track to provide better remuneration to its shareholders. In the first half of 2018, the company has paid cash dividends of approximately $189.1 million and repurchased shares worth $212.7 million. In the years ahead, the company intends to follow its 50/50 capital allocation strategy of acquisitions and rewarding shareholders. Dividend payout is predicted to be 30-35% in the long haul.

Escalating Costs: A Concern

Over the past three months, Stanley Black & Decker's shares lost 7.3%, compared with 6.8% decline recorded by the industry  it belongs to.

Companies like Kennametal Inc. KMT , Actuant Corporation ATU and Lincoln Electric Holdings, Inc. LECO are grouped in the same industry. Notably, reflecting negative analyst sentiments, the Zacks Consensus Estimate for the company's earnings has moved south for 2018 and 2019, in the past 30 days.

We notice that escalating cost of sales and operating expenses has become a major cause of worry for Stanley Black & Decker. In the second quarter of 2018, its cost of sales increased 14.7% year over year while selling, general and administrative expenses grew 6.1%. Gross margin was down 210 bps year over year as commodity inflation of $50 million and forex woes negated positive impacts of volume growth, favorable pricing and improved productivity. Operating margin contracted 110 bps year over year. We believe, if unchecked, rising costs and expenses can hurt the company's margins in the quarters ahead. For 2018, the company anticipates commodity inflation - in steel, base metals, batteries and others, including resin, components, fuel and packaging - to be approximately $205 million. Further, tariffs on steel and aluminum (Section 232) and the initial $34 billion on componentry and certain finished goods (Section 301) are predicted to have an adverse impact of $35 million in 2018. These two factors are predicted to lower earnings by 30 cents per share in 2018.

We believe that the geographically diversified business of Stanley Black & Decker has exposed it to risks arising from adverse movements in foreign currencies and geopolitical issues. While foreign currency translations had a positive impact of 1% on sales in the second quarter of 2018, strengthening of U.S. dollar in the second quarter of 2018 will have an adverse 40 cents per share impact on earnings.

Stanley Black & Decker, sometimes to finance its buyout activities and working capital needs, raises funds through the issuance of long-term debts instruments and equities. This in turn, could hurt the company's cost of funds, liquidity and access to capital markets in case of degradation in investment grade ratings. Exiting the second quarter of 2018, the company had a long-term debt balance of $2,831.2 million, roughly flat sequentially. Its interest expense has increased 13.3% year over year in the first half of 2018. For 2018, high debt levels to address working capital requirements and higher interest rates will result in an increase in interest expenses.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Business , Stocks
Referenced Symbols: ATU , SWK , KMT , LECO

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