SWK – Improving Returns, Strong Cash Flows and Attractive Valuation

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Graham Copley / Nick Lipinski



October 7th 2015

SWK – Improving Returns, Strong Cash Flows and Attractive Valuation

  • Stanley continues to make progress in returning to its long term return on capital trend
    • Valuation is still intriguing albeit off the lows seen in 2013
  • The 8% organic growth seen in the first two quarters of 2015 is likely to moderate to a still robust mid-single digit range
  • The company’s brands continue to gain share in developed markets and there remains a sizable opportunity for SWK in emerging markets (still less than 20% of sales)
  • Cash flows are impressive and growing
    • On a FCF yield basis SWK is one of the most attractive stocks in the large cap Capital Goods space (7.6%)
  • Multiple options are now available for these cash flows, with acquisitions back in play after a multiyear moratorium and share repurchase activity accelerating
  • This in addition to the steadily growing dividend, currently yielding 2.3% at just over $2 per share
  • The strength of Stanley’s brand portfolio and its global scale and robust innovation engine will likely make the company one of the more insulated from the threat of Chinese export substitution
    • Negative revisions have been much more muted for SWK compared to the sector
  • SWK remains one of our favored stocks in Capital Goods arena, along with CAT, DE and TRN

Exhibit 1

Valuation – Less Cheap, but Still Attractive

SWK is now trading at less of a discount than it was when it first caught our attention, but it remains attractively valued on our normalized earnings framework. The company’s long term return on capital trend suggests 30% upside to a “normal”, mid-cycle value of ~$130 per share. Return on capital has trended steadily higher since the trough in early 2012.

Exhibit 2

Source: Capital IQ, SSR Analysis

Organic Growth off the Charts

The robust organic growth figures reported over the past four quarters have been driven by considerable share gains in the European tool market, steady improvement in US residential construction, and the Engineered Fastening business which has continued to outpace the healthy rate of automotive production. Stanley is approaching difficult comparisons in the back half of the year, and organic growth is expected to come in slightly to the mid-single digit range – an enviable figure given the number of large cap Industrial companies reporting marginal to negative organic growth. The core Tools business appears to have a significant opportunity to gain in emerging markets, which currently represent just 17% of segment sales.

Exhibit 3

Source: Capital IQ, SSR Analysis

Cash Flows Substantial and Growing

With acquisitions on the back burner for the past two years, Stanley has done an excellent job of reaping the cash flows from its acquisitive spree in the early years of the decade. Free cash flow is expected to surpass $1 billion over the next twelve months – Exhibit 4. On a free cash flow yield basis, SWK looks like one of the best values among the large cap names in the sector – Exhibit 5.

Exhibit 4

Source: Capital IQ, SSR Analysis

Exhibit 5

Source: Capital IQ, SSR Analysis

Multiple Options for Cash Deployment – M&A Back in Play, Repurchases Picking Up

Stanley has been absent from the M&A market since 2013 after making a string of acquisitions earlier in the decade – Exhibit 6. This has historically been an effective growth driver for the company and the recently announced resumption of M&A will target Tools and Engineered Fastening businesses, with modest sized deals in the $500 million range coming as early as late 2015. These are the most sensible strategic areas for SWK to focus on, given its core competencies in the Tool market and the relatively high growth rates in automotive production (which the Engineered Fastening business has been steadily outpacing). The step back from the Security market is assuring, but perhaps not unexpected in light of the well-documented difficulties that plagued SWK following its most recent major acquisition (the former Securitas in 2011 for $1.4 billion).

Exhibit 6

Source: Capital IQ, SSR Analysis

In recent years SWK has maintained and modestly expanded its dividend, as it has every year since 1968, but share repurchases have been less of a focus. While M&A takes greater precedence, the magnitude of Stanley’s cash flow should provide for further “opportunistic” buybacks moving forward.

Exhibit 7

Source: Capital IQ, SSR Analysis

No Major China Concerns

Brand reputation is one of Stanley’s major competitive advantages, and we believe the company’s brands are entrenched enough to remain insulated from Chinese imports. The increase in brand awareness over the past decade (Exhibit 8) is partly the result of dedicated advertising efforts (Exhibit 9), which stepped up in 2010 with the addition of Black & Decker’s portfolio of brands.

The company has actually been on the offensive with respect to Chinese competition, acquiring Chinese tool maker GQ in 2013 as a means of building up its mid-price point tool offering in the country.

SWK’s estimates have held in considerably better than the Capital Goods sector on average year to date, and the stock has shown relative strength during the recent China/commodity centered sell-off – Exhibit 10.

Exhibit 8

Source: Company Filings, SSR Analysis

Exhibit 9

Source: Capital IQ, SSR Analysis

Exhibit 10

Source: Capital IQ, SSR Analysis

©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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