Interest rates are the Fed When issuing credit assessments, rating agencies tend to favor key industry players, like Stanley Black & Decker (SWK), a renowned company in the industrial tools and hardware business. Despite the company’s questionable move and unexciting cash flow levels, it received a safe investment-grade rating. In today’ FA Alpha Daily, we will uncover the true creditworthiness of Stanley Black & Decker using Uniform Accounting.
FA Alpha Daily:
Wednesday Credit
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Rating agencies often view industry leaders with a favorable lens, attributing their established market presence to potential financial stability and resilience.
This outlook is rooted in the belief that companies dominating their sectors have the strategic advantage to sustain operations even during tough market conditions, warranting them stronger credit ratings.
Stanley Black & Decker (SWK), a well-known company in the industrial tools and hardware business, is an example of a market leader.
The brand has earned a reputation for quality and dependability over the years due to its vast product line, which includes anything from power equipment to garden accessories.
It has not only equipped professionals across various industries but also catered to the do-it-yourself (“DIY”) needs of consumers globally, establishing a broad customer base.
However, despite its size, Stanley Black & Decker has not been immune to adversity.
In recent years, the company faced hurdles ranging from supply chain disruptions to changing consumer behavior.
As a result, the company’s Uniform return on assets (“ROA”) took a dip from the historically stable 28% levels to 10% last year.
In response to these pressures, the company made the significant decision to divest itself of certain assets, selling its Electronic Security Solutions and Healthcare Solutions Businesses for $3.2 billion.
This move was intended to streamline its focus on its core businesses and improve its financial position.
However, the strategy took an unexpected turn when Stanley Black & Decker decided to reinvest $2 billion of the proceeds from these divestitures into share buybacks.
Given that the company’s cash flows are not especially robust as we’ll discuss later on, this was a hard decision.
While share buybacks can be a sign of confidence to investors, they can also signal that the company might not have better growth opportunities to invest in.
Furthermore, this financial strategy emerges at a time when the global economy is witnessing volatility, with consumer spending habits shifting and interest rates on the rise.
The macro headwinds make the balancing act between returning value to shareholders and maintaining a healthy cash reserve even more delicate. Thus, the move becomes riskier.
Even with these tough spots and tricky decisions, rating agencies usually still think well of big, well-known companies.
They seem to be paying less attention to the complexities since they are more concerned with the company’s reputation and market position.
Therefore, S&P gives Stanley Black & Decker an “A-” rating. This rating indicates that there is a very low credit risk in the next five years, solidifying the company as a safe investment-grade option.
We think a riskier credit rating is more appropriate considering its current financial status and looming debt maturities.
We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (“CCFP”) to understand how the company’s obligations match against its cash and cash flows.
In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
The CCFP chart shows that Stanley Black & Decker’s cash flows are barely enough to support its obligations going forward.
The chart shows that the firm has some significant debt maturities over the next five years and that its cash flows may not be sufficient for its obligations next year. Also, it seems that the company may have difficulties with that limited buffer in case of an economic downturn.
Additionally, with the current high interest rate environment, refinancing these debt maturities may become more expensive.
Furthermore, given the company’s risky practice of repurchasing shares under these conditions, we feel the credit risk is worse than what the rating agencies acknowledge.
Therefore, we assigned the company a “HY1-” rating, placing it in the high-yield category and acknowledging its higher credit risk.
It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.
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SUMMARY and Stanley Black & Decker (SWK:USA) Tearsheet
As the Uniform Accounting tearsheet for Stanley Black & Decker (SWK:USA) highlights, the Uniform P/E trades at 22.6x, which is higher than the global corporate average of 18.4x, but below its historical P/E of 27.5x.
High P/Es require high EPS growth to sustain them. In the case of Stanley Black & Decker, the company has recently shown a 56% Uniform EPS shrinkage.
Wall Street analysts provide stock and valuation recommendations, that in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Stanley Black & Decker’s Wall Street analyst-driven forecast is for a 76% EPS shrinkage and a 428% EPS growth in 2023 and 2024, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Stanley Black & Decker’s $86 stock price. These are often referred to as market-embedded expectations.
Furthermore, the company’s earning power in 2022 was 2x the long-run corporate average. Moreover, cash flows and cash on hand are below its total obligations—including debt maturities and capex maintenance. The company also has an intrinsic credit risk that is 210bps above the risk-free rate.
Overall, this signals a moderate credit risk.
Lastly, Stanley Black & Decker’s Uniform earnings growth is below its peer averages, but is trading above its average peer valuations.
Best regards,
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
This analysis of Stanley Black & Decker (SWK)’s credit outlook is the same type of analysis that powers our macro research detailed in the member-exclusive FA Alpha Pulse.