Investors have already started making moves on the basis of positioning themselves for the expected recovery in U.S. housing, but the leading tool company Stanley Black & Decker (NYSE:SWK) has yet to really go along for the ride. While housing-related stocks like Louisiana-Pacific (NYSE:LPX) and Mohawk (NYSE:MHK) have both nearly doubled over the past two years, Stanley Black & Decker stock is basically where it started.
Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.
Some of the lagging performance can be explained with stubbornly low margins and an increasingly debt-heavy balance sheet. At the same time, management has sold some of its housing-related assets and acquired an industrial fasteners business that offers uncertain long-term margins and cash flows at this point. All told, Stanley Black & Decker's stock is a curious proposition – while it is hard to argue that the shares are cheap on the basis of what we've seen recently, a strong recovery in the North American construction market coupled with a return to double-digit free cash flow margins would likely be powerful drivers for the stock.
A U.S. Recovery Would Help, But The Future Is Elsewhere
It's hard to argue that Stanley Black & Decker hasn't been hurt by the severe downturn in the U.S. housing market and construction activity. A leading tool manufacturer (alongside rivals like Techtronic (OTC:TTNDY), Makita (OTC:MKTAY), and Snap-On (NYSE:SNA)), Stanley Black & Decker has languished with the downtrend in construction activity, both residential and commercial. With that, and a series of acquisitions, a lot of the company's operating leverage has gone away.
SEE: Analyzing An Acquisition Announcement
Although SWK isn't quite as leveraged to a U.S. housing recovery as some may believe (I would estimate around 20-25%), an overall recovery in construction activity would clearly help the company's consumer and professional tool businesses.
But management isn't building its plans for the future around that recovery. Instead, management has prioritized emerging market growth as a key driver for the future. Stanley Black & Decker enjoys solid brand recognition in multiple overseas markets, but the key now is to improve the marketing, manufacturing, and distribution so as to be a competitive player in these markets – many of which have not only greater construction activity than the U.S., but rising home ownership levels that bode well for consumer tool demand.
Industrial Exposure Still An Unproven Benefit
Although Stanley Black & Decker established a very solid long-term track record in tools and security products, management has decided that becoming more of an industrial supplier is the way to go. To that end, the company has been bulking up its scale in the fasteners business.
It's not an entirely unreasonable approach. The market for industrial fasteners is enormous and fragmented – even large companies like Illinois Tool Works (NYSE:ITW), Alcoa (NYSE:AA), and Anixter (NYSE:AXE) have relatively low overall market share – and modern aircraft, automobiles, and commercial vehicles require more fasteners than ever before. It's unclear to me, though, whether SWK will be able to establish a real moat or competitive advantage in this industry, and whether these ventures will ultimately weigh down margins and free cash flow production relative to historical levels.
Security Still An Unknown
Stanley Black & Decker has a strong business in security monitoring (where it is #2 behind Tyco (NYSE:TYC) and mechanical security products (like locks), where it is #3 behind Assa Abloy and Ingersoll Rand (NYSE:IR) (which is spinning off its security business). The acquisition of Niscayah has not gone particularly well, though, and there has been a near-constant drumbeat for Stanley Black & Decker to sell this business. Management seems wishy-washy on this point – while they have said they would perhaps consider a transaction, they're not actively looking for one at this point.
SEE: 5 Must-Have Metrics For Value Investors
The Bottom Line
My biggest concern about Stanley Black & Decker as a stock is that management has not only diluted the company's leverage to an eventual North American construction rebound, but also altered the long-term margin and cash flow profile (and not for the better). If the company could couple mid-single digit revenue growth with a relatively prompt return to low double-digit free cash flow margins, these shares would be interesting today. As it is, though, that seems like an aggressive assumption and these shares don't look like a compelling bargain at present.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.