Stanley Black & Decker's turnaround is in full swing, and we're raising our price target

Published Tue, Aug 1 20233:09 PM EDT

Stanley Black & Decker (SWK) reported a solid second quarter Tuesday, demonstrating it's becoming a more streamlined business through cost cuts, inventory reductions and an improved supply chain. With gross margins improving and earnings growth inflecting next year, we're sticking with the stock and looking to add to our position on potential pullbacks. Revenue for the three months ended June 30 fell 5% year-over-year, to $4.16 billion, slightly beating analysts' forecasts of $4.14 billion, according to estimates compiled by Refinitiv. Adjusted earnings-per-share (EPS) came in at a loss of 11 cents, down from a $1.77-per-share profit last year but ahead of Wall Street's prediction of a 37 cent-per-share loss, Refinitiv data showed. The stock soared more than 4% Tuesday, to roughly $103.50 a share. Bottom line Fresh signs that the turnaround at Stanley Black & Decker — a leading manufacturer of industrial tools and household hardware — is in full force has us bullish about its potential earnings power in a more normalized environment. The increasingly likely return to profitability in the second half of this year should support the stock's rally. As a result, we're raising our price target to $110 a share, up from $100. At the same time, demand for its quality tools has remained solid due to resilient housing market end strength from its professional customers, like contractors, which account for about 70% of its tools business. Although the so-called do-it-yourself (DIY) market is still somewhat soft, it could still pick up as high mortgage rates keep people in their homes. When we started this position in mid June , we were attracted by the series of initiatives Stanley had announced to finally get over its Covid-19 housing-boom hangover and supply-chain slipups. The hefty dividend yield, which was 3.8% at the time of our buy, paid us as we waited for the turn. With another quarter under its belt, management is one step closer at getting the business to its goal of growing organically at a rate two-to-three times its market, with 35%-plus adjusted gross margins by 2025. Quarterly commentary Stanley Black & Decker is in the midst of a business transformation, as it overhauls its cost structure and supply chain, while cleaning up its inventory position. And the company made significant progress on its restructuring plan this quarter. It's global cost-reduction program – which focuses on supply-chain optimization and company simplification — drove $230 million in pretax run-rate savings in the quarter, putting the firm on track for $1 billion in annualized savings by the end of the year. Inventory was down $400 million in the quarter, bringing the year-to-date total reduction to $1.4 billion. But there are two important aspects of this inventory wind down. One is that Stanley is prioritizing the sell-through of its higher-cost inventory. Once Stanley gets through that, it will see a big step up in adjusted gross-margin expansion. Crucially, Stanley isn't sacrificing on price to work through its inventory. Instead, it's producing less. Taken together, the company's adjusted gross margins were 23.6%, down from last year's 27.9% rate. But what matters in a turnaround is the trend. That's why we were pleased to see adjusted gross margins expand 50 basis points from the first quarter. With all that higher-cost inventory now behind Stanley and costs continuing to be taken out, we expect gross margins to move significantly higher in the second half of this year and into the next — positioning the company to earn somewhere in the range of $4 to $5 per share in 2024. 2023 outlook When management provided its first view of 2023 many months ago, it initially provided wide ranges for adjusted EPS and free cash flow to account for uncertainties facing the business and its multiyear strategic plan. Following a first half of the year that featured a $575 million reduction in inventory and $460 million of pre-tax run-rate cost savings, both ahead of schedule, the company now has a clearer picture on its outlook. Management narrowed its full-year adjusted EPS guidance to be in a range of 70 cents to $1.30, compared with a previous range of $0 to $2 a share. The midpoint of the new range remains the same, at $1 a share, which compares favorably to Wall Street's 94 cent-per-share consensus estimate. This midpoint now factors in a "modestly lower" organic-growth rate, offset by stronger gross margins. Management made a similar change to its estimated range for full-year free cash flow, narrowing its expectation to be in range of $600 million to $900 million, compared with a prior range of $500 million to $1 billion. The $750 midpoint remains consistent. Consensus expectations for free cash flow remain above the guidance, at about $1.06 billion. (Jim Cramer's Charitable Trust is long SWK. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. 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Stanley Black & Decker drills are displayed for sale at a Home Depot store in Emeryville, California.

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