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Pass On Stanley Black and Decker

I recommend you pass on Stanley Black & Decker (SWK) despite its attractive dividend metrics and appealing valuation. Just because it:

  • has increased its dividend for 55 consecutive years;
  • has a current dividend yield of ~2.76%;
  • is attractively valued; and
  • shares are trading near a 52-week low

does not make this a good long-term investment.

First and foremost, investment decisions based on a company’s dividend metrics and/or on a company’s stock price relative to historical levels are ill-advised. Investors would be wise to look at an investment’s TOTAL potential return. While dividends do contribute to an investment’s return, they are often a small component of the overall return.

My recommendation that you pass on Stanley Black and Decker is because there are far better investment opportunities to be found. Many such investment opportunities are companies that distribute no dividends, or which are very low dividend-yielding. Despite these inferior dividend metrics, they have a track record of reinvesting earnings to generate very attractive returns.

I fully appreciate the past does not predict the future but if a company has a proven long-term track record, there is reasonable probability investors can expect more of the same going forward. Investing, however, is dependent on many factors so what might be a suitable investment for one might not be for another.

Pass On Stanley Black and Decker
Pass On Stanley Black and Decker

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Just because I recommend you pass on this Dividend King does not mean Stanley Black and Decker is not suitable for you. I know that dividend income can soften the blow during periods in which equity prices experience headwinds. Investors who fret over sudden and steep declines in share prices might sleep better knowing that at least they will receive dividend income. If, however, we invest in great companies that are experiencing temporary headwinds then a drop in a company’s stock price presents a buying opportunity!

How many people WANT to make a major purchase when prices are high? Not many. Typically, we want to buy when prices are low. When we overpay it is often because we let our emotions influence our decision-making process. Investing in companies is much the same. You should want to buy when valuations are attractive. What is important is an attractive valuation and not price. A company’s stock price in and of itself is meaningless.

If we invested in a company at $200/share 5 years ago when the company’s EPS was $10, the PE multiple was 20. If we acquire shares in the same company today at $300 but its EPS is $18, the PE multiple is ~16.7. The current share price is higher but we are now acquiring shares at a better valuation. Naturally, other metrics must factor into our analysis. However, this simple example demonstrates why comparing a company’s current and historical stock prices are not prudent.

In this post, I lay out my reasoning for why I do not recommend this Dividend King.

SWK Stock Chart
Source: Stock Rover*

Company Overview

You are likely familiar with SWK to some extent. If not, I suggest you check the company’s website. In addition, I very strongly recommend you review the most current Form 10-K. Item 1 and 1A provide a great overview of the company and the risk factors. This Investor Presentation also contains valuable information.

Acquisitions

In August 2021, SWK announced the acquisition of the 80% ownership stake in MTD Holdings Inc. (MTD), a privately held global manufacturer of outdoor power equipment, including Cub Cadet® and Troy-Bilt®, for $1.6B in cash; SWK acquired a 20% stake in MTD in 2019. The announcement of the completion of this acquisition was on December 1, 2021.

In September 2021, SWK announced that it had entered into a definitive agreement to acquire Excel Industries for $0.375 in cash. The announcement of the completion of this acquisition was on December 1, 2021.

Following these acquisitions, management believes that SWK is now the outdoor power equipment leader.

Through these acquisitions, SWK has added 8 manufacturing locations. This gives it the instant capacity to support growing demand. Furthermore, the extensive manufacturing footprint gives SWK a competitive advantage over its small-format, electric-only competitors.

Divestitures

In Q4 2021, SWK announced the sale of its Electronic Security business to Securitas for $3.2B. In late April 2022, SWK announced the sale of its Access Technologies business for $0.9B in an all-cash transaction. SWK has now completely divested itself of its security business.

SWK - Portfolio Optimization and Capital Allocation - April 28 2022
Source: SWK – Q1 2022 Earnings Presentation

The acquisitions and divestitures were part of SWK’s plan to become more profitable and streamlined. SWK anchors its Outdoor strategy on the following 4 pillars:

  • electrification;
  • brand and channel strength;
  • cutting-edge innovation; and 
  • large-format manufacturing capacity and experience.

Following these acquisitions and divestitures, SWK is now one of the leading industry participants in the ~$25B outdoor power equipment market that is capable of growing 10% – 15% organically with a mid-teens operating margin for many years. This business is also expected to lead in the electrification of both large-format and handheld professional outdoor power equipment. SWK also plans to bring its differentiated line of autonomous electrified products under the DEWALT brand to the professional landscaping channel. This market consists of a network of independent dealers with 2,500 unique outlets, skewing towards the pro market and representing ~50% of the ~$25B addressable market.

Financials

Before a very brief look at SWK’s Q1 2022 earnings, investors should be aware that the company restated its FY2018, FY2019, and FY2020 results. The reason for this restatement is found here. We see that FY2020 diluted GAAP EPS was overstated by $0.31. While seemingly insignificant, this error means that with a ~29 FY2020 PE multiple, shares were overvalued by ~$9/share.

Q1 2022 Results

On April 28, 2022, SWK released Q1 2022 results. All related material is accessible here. Following the acquisitions and divestitures noted above, SWK now derives its earnings from its Tools and Outdoor and Industrial segments.

SWK - Q1 2022 Revenue Breakout - April 28 2022
Source: SWK – Q1 2022 Earnings Presentation

In Q1, SWK generated ~$4.4B in revenue. On the earnings call, management indicated that customer demand remained strong across many of the company’s global markets and price realization accelerated from Q4. Despite cost inflation and supply chain challenges, SWK generated adjusted EPS of $2.10 which was ahead of plan.

SWK - Q1 2022 Key Messages - April 28 2022
Source: SWK – Q1 2022 Earnings Presentation

The supply-constrained environment in which SWK is making progress to resolve has dampened volume. The added supply of semiconductors and electronic components in Q1 is expected to be able to alleviate all major electronics-related constraints by the end of Q2.

On the demand front, SWK believes it is gaining North American market share in the Tools & Outdoor segment. This observation is based on publicly available disclosures by SWK’s top 2 home center customers (Home Depot and Lowe’s).

While the boom global conditions of 2020 and 2021 have leveled off, the fundamentals and secular drivers remain healthy and are still very much intact. The combination of repair/remodel, new residential construction, and commercial construction is expected to drive enduring demand in many of SWK’s markets around the world during the remainder of 2022.

Despite slowing global growth and increasing U.S. interest rates, SWK thinks repair/remodel activity is expected to grow at mid- to high single-digit rates over the next 2 years due to:

  • an aging housing stock; and 
  • record levels of home equity and strong price appreciation.

This should drive big ticket remodeling. Furthermore, the tight existing housing supply is expected to lead consumers to invest in existing homes and spur the demand for new homes.

Free Cash Flow

As a result of lower FY2022 guidance and higher inventory values at year-end due to the additional wave of inflation experienced in Q1, SWK’s FCF guidance has been lowered. When management released its FY2021 results and FY2022 guidance on February 1, 2022, FCF guidance was ~$2B. Guidance is now ~$1B – ~$1.5B.

FY2022 Guidance

When management released its FY2021 results and FY2022 guidance on February 1, 2022, guidance called for 2022 diluted GAAP EPS of $10.10 – $10.70 and 2022 adjusted diluted EPS of $12.00 – $12.50. This guidance is inclusive of one-time charges related to restructuring expenses, a voluntary retirement program, the Russian business closure, and acquisition-related costs. Furthermore, the current estimate for pretax charges in FY2022 is ~$0.46B.

SWK - FY2022 Guidance - April 28 2022
Source: SWK – Q1 2022 Earnings Presentation

Credit Ratings

Far too often, investors pay little or no attention to the degree of risk they are assuming when investing. It pains me to read stories on social media from ‘investors’ having completely lost their life savings after having invested in ‘junk’. People who were saving money for tuition, the purchase of a new home, or to start a business ended up ‘investing’ their money in cryptocurrencies or in companies that were doomed for failure.

I am fully aware not every investment decision will be a ‘winner’. A little bit of research (including a company’s credit risk) BEFORE investing in a company, however, can improve our investment experiences.

Looking at SWK, the current domestic unsecured long-term debt ratings and outlook are:

  • Moody’s: Baa1 (stable)
  • S&P Global: A (stable)
  • Fitch: A- (stable)

The rating assigned by S&P Global is the middle tier of the Upper medium grade category. That assigned by Fitch is the bottom tier of the Upper medium grade category. The rating assigned by Moody’s is the top tier of the Lower medium grade category.

S&P Global and Fitch define SWK as having a strong capacity to meet its financial commitments. It is somewhat more susceptible, however, to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

Moody’s views SWK as having an adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.

All 3 ratings assigned to SWK are investment grades and are satisfactory for my purposes.

Dividends and Share Repurchases

Dividend and Dividend Yield

SWK expects to distribute ~$0.5B in dividends during FY2022.

SWK prides itself on its lengthy dividend history and one of its priorities is to increase the dividend annually; the company consistently generates sufficient cash flow from operations to service the dividend. According to Dividend Radar, SWK has increased the dividend 55 years in a row. The company is a Dividend King and a Dividend Aristocrat.

Portfolio Insight - Dividend Growth SWK
Source: Portfolio Insight*

Although I consider a company’s dividend policy when I make investment decisions, I focus on an investment’s total potential investment return. It makes very little sense to invest in SWK for a ~2.76% dividend yield (SWK’s current dividend yield according to Portfolio Insight*) if SWK’s total average annual return over the past 20 years (with reinvested dividends) has only been 7.71%. A broad-based ETF generated a 9.04% average annual total return over the same timeframe.

Portfolio Insight - Dividend Yield History SWK
Source: Portfolio Insight*

Another consideration is the type of account in which we hold SWK shares. Hold shares in a taxable account and the dividend income must be declared annually. Depending on an investor’s circumstances, the after-tax dividend yield could be below the level posted on various stock screeners.

As a Canadian, I also incur a 15% dividend withholding tax on any dividend income from US holdings I hold in taxable accounts. That $0.79/share/quarter dividend? Nope, I don’t receive that. I only receive $0.6715/share/quarter. SWK wasn’t an appealing investment before accounting for the dividend withholding tax haircut. Now it is even less appealing.

Share Repurchases

Share repurchases are wonderful when shares are undervalued. In the case of SWK, recent share repurchases appear to be a wise means by which to reward shareholders.

The average shares outstanding over the FY2012 – FY2021 timeframe (in millions of shares) is 167, 159, 160, 153, 148, 152, 157, 156, 162, and 165. In Q1 2022 this had increased to 165.4.

In February 2022, SWK executed open market share repurchases for a total of 1,888,601 shares of common stock for $0.3B.

When SWK released FY2021 results, it announced that a ~$4B Share Repurchase Program would likely begin in Q1 2022. In March 2022, it executed a ~$2.3B accelerated share repurchase (‘ASR’). This was funded through borrowings under one of its existing 364-Day committed credit facilities. The ASR terms provide for an initial delivery of 85% of the total notional share equivalent at execution, or 10,756,770 shares. The final delivery of the remaining shares under the ASR is expected to be completed by the end of Q2 2022.

Since lower cash flow in FY2022 is now projected, SWK is deferring the remaining ~$1.7B repurchase until 2023. SWK has made this change as part of its capital allocation approach that aims to balance share repurchase activity with a commitment to dividends and strong investment-grade credit ratings.

Valuation

Deciding to purchase a company’s shares because they are at or near a 52-week low has to be one of the most asinine ways by which to make an investment decision. Many investors, however, rely heavily on a company’s stock price when making their investment decision yet a company’s stock price is meaningless when viewed in isolation!

Case in point…Nikola Corporation (NKLA). Before it was claimed that its development of an electric truck was misleading, the company’s shares peaked at ~$66 in mid-2020. The shares now trade at ~$7.30. Does this suddenly make NKLA a good investment? No. This company is still junk.

Forget 50-day and 200-day moving averages. Merely looking at stock charts is an extremely poor way to invest in a company unless you think driving a car only by only looking in a rearview mirror is a good way to drive. In addition, comparing a company’s current and future performance can lead to misleading investment decisions especially when a company completes various acquisitions and divestitures that significantly change the business.

Using a company’s guidance and estimates generated by the brokers who cover a company to determine a company’s valuation is preferable. If you want, you can also use SWK’s historical diluted PE levels to see how the current valuation stacks up relative to the historical valuation. However, it is important not just to take these historical PE levels at face value. Sometimes there are unique circumstances that may have skewed a company’s valuation in prior years. Look at SWK’s income statement over the past several years and we see line items such as ‘Gain on Sale of Business’, ‘Restructuring Charges’, ‘Provisions for Credit Losses’, and ‘Income Taxes’ that can exhibit wide swings from year to year.

SWK’s FY2012 – FY2021 diluted PE levels are 27.40, 22.41, 22.19, 19.30, 17.43, 21.45, 18.42, 38.19, 28.89, and 16.71.

SWK’s current FY2022 guidance calls for $7.20 – $8.30 in diluted EPS and $9.50 – $10.50 in adjusted diluted EPS. With shares currently trading at ~$116.60, the forward diluted PE range is ~14 – ~16 and ~11 – ~12.3. Current broker estimates and the current ~$116.60 share price gives us the following forward adjusted diluted PE levels.

  • FY2022 – 18 brokers: $9.86 mean and $8.78 – $10.25 range. The valuation using the mean is ~11.8.
  • FY2023 – 17 brokers: $11.53 mean and $9.61 – $13.31 range. The valuation using the mean is ~10.1.
  • FY2024 – 10 brokers: $12.87 mean and $10.73 – $14.54 range. The valuation using the mean is ~9.

There is no denying that the valuation is attractive, but I still suggest passing on Stanley Black and Decker.

Pass On Stanley Black and Decker – Final Thoughts

Despite Stanley Black and Decker’s attractive dividend record and valuation, I recommend you pass on this Dividend King. Many other companies that have retraced to attractive valuation levels offer the potential for far superior total long-term investment returns than SWK.

I have recently been adding to existing positions in several such companies and suggest you might want to analyze some of them to determine if they are suitable for you.

Thanks for reading Pass on Stanley Black and Decker.

Another article by Charles Fournier is Brookfield (BAM) Plans To Become Asset Light.

Author Bio: I am a self-taught investor and run the Financial Freedom is a Journey blog. I have invested in the North American equities markets for over 34 years. I retired from a career in banking and continue to invest as this is something about which I am passionate.

Author Disclosure: I hold no position in SWK and have no intention of initiating one in the foreseeable future. I disclose holdings held in the FFJ Portfolio and the dividend income generated from these holdings. I do not disclose details of holdings held in various tax-advantaged accounts for confidentiality reasons.

Author Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

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