Stanley Black & Decker Stock: A Massive Mean-Reversion Opportunity Awaits (NYSE: SWK )

JR Research Stock Market SWK


Stanley Black and Decker Building in Mississauga, On, Canada

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Thesis

Stanley Black & Decker, Inc. (NYSE: SWK) stock has experienced intense selling pressure since crashing from its highs in May 2021. The worsening macroeconomic environment and an increasingly hawkish Fed added fuel for bearish investors as they pummel SWK. As a result, SWK remains more than 60% below its 2021 highs as the bottom continues to elude buyers.

However, we infer that sales momentum should approach its long-term bottom, despite the impending housing market correction. We assume that the market has significantly downgraded SWK in anticipation of these challenges. Stanley Black & Decker would also face less challenging competitions from 2023, following the massive consumer-driven recovery from its COVID bottom. We also expect inflation and supply chain headwinds to ease through FY24, supporting the company’s cost-cutting and business transformation efforts to restore its gross margins.

Therefore, we postulate that the reward-to-risk profile at current levels favors a highly attractive mean reversion opportunity for investors adding at current levels. Nonetheless, we must emphasize that we have yet to observe a sustained bottom process that suggests the bears are running out of momentum. Therefore, investors should still expect short-term downside volatility, which we believe should be viewed as an opportunity to average decline.

As such, we rate SWK a Buy and encourage investors to start chipping in.

SWK has been substantially downgraded

SWK NTM EBITDA multiple valuation trend

SWK NTM EBITDA multiple valuation trend (koyfin)

As seen above, SWK’s NTM EBITDA multiple reached the one standard deviation zone below its 10-year average at its July lows. While its declining EBITDA estimates have impacted its forward multiples, we urge investors to look forward to beyond 2023 as Stanley Black & Decker executes its profitability recovery plans.

Therefore, we infer that the market has already significantly downgraded SWK, reducing the current levels for investors, given the short-term headwinds.

SWK’s growth has already normalised

SWK Revenue by Segment Change %

SWK Revenue by Segment Change % (Company Filings)

SWK saw growth in its critical tools and storage segment from the highs in H1’21, as seen above. Despite its 17% rise in the second quarter, it gained a 7% contribution from its MTD and Excel acquisitions, along with pricing changes.

Despite that, the Industrial continued its recovery momentum from its low point in Q4’21, given the strong cadence of its automotive and aerospace customers. However, this was insufficient to offset the impact on its tools and storage segment.

SWK revenue change % and adjusted EBIT change % consensus estimates

SWK revenue change % and adjusted EBIT change % consensus estimates (S&P Cap IQ)

The consensus estimates (neutral) suggest that the headwinds on its revenue and operating profit growth should continue through FQ1’23 before recovering. Management remains confident that we should expect some of its near-term headwinds related to increased commodity prices and supply chain costs to abate.

Our analysis of the commodity markets suggests that costs have indeed fallen through H2’22. Furthermore, global freight costs continued to fall through September, down more than 20% from early August. Likewise, global supply chain pressures eased markedly, reaching early 2021 levels in August. Therefore, we are confident that the estimates are credible as SWK seeks to rejuvenate its operating leveraged profits.

SWK adjusted gross margins % and adjusted EBIT margins % consensus estimates

SWK adjusted gross margins % and adjusted EBIT margins % consensus estimates (S&P Cap IQ)

The company planned to restore its adjusted gross margins to 35% by 2024. As seen above, Stanley Black & Decker posted an adjusted gross margin of 27.9% in the second quarter as inventory costs and a reduction in scale impacted its profitability.

However, the company expects underlying costs to improve further along with its extensive cost rationalization program to further increase its margins. In addition, it also expects its supply chain reorganization to boost its recovery on its medium-term gross margins target.

Therefore, investors are encouraged to evaluate the company’s progress from Q1’23, as the consensus estimates suggest that its bottom may not occur until Q4’22.

Is SWK stock a buy, sell or hold?

SWK adjusted EPS and Dividend per share consensus estimates

SWK adjusted EPS and Dividend per share consensus estimates (S&P Cap IQ)

Despite the compression in its adjusted EPS from its 2021 highs, the company’s payout ratios remain reasonable. Accordingly, we are confident that its dividend strategy should not be affected. Also, the recovery in its profitability growth through FY23 should support the growth in its forward dividend payouts.

SWK TTM Dividend yield % consensus estimates

SWK TTM Dividend yield % consensus estimates (S&P Cap IQ)

Therefore, we judge its TTM dividend yield on a trailing-twelve-month basis to be attractive at 3.8% (versus 10Y average of 2.08%). Therefore, we believe that this should support SWK’s recovery momentum, given the significant blow it has endured since its 2021 highs.

SWK price chart (monthly)

SWK price chart (monthly) (TradingView)

The swing in SWK over the past year has seen it collapse near its long-term support, based on its March 2020 lows.

While this appears to threaten its long-term bullish bias, we postulate the magnitude and pace of its decline appears to be a quick downgrade to reduce its valuations to more reasonable levels. We therefore do not expect SWK to move into a secular downtrend, given the expected recovery of its medium-term profitability.

Therefore, we believe that the reward-to-risk profile looks attractive for SWK, given the significant mean-reversion potential to its long-term moving averages. Despite the potential for near-term downside volatility, we think investors should find the opportunity for a medium-term re-rating attractive at current levels.

Consequently, we rate SWK as a Buy.



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