Increased Focus on Portfolio Rationalization Makes This Stock an Attractive Buy

By Ankit Agrawal - September 17, 2012 | Tickers: DHR, HD, SNA, SWK | 0 Comments

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Stanley Black & Decker Inc's (NYSE: SWK) growth outlook has been buffered by the realization of cost & revenue synergies from the merger with Black & Decker and accretion from the recently completed Niscayah (Security) acquisition. I am impressed by the company's track record of finding and completing suitable acquisitions to boost long-term sales and earnings growth rates. I'm optimistic that the recently announced Infastech acquisition and the sale of Hardware & Home Improvement (HHI) will drive positive results in 2013. Also, I believe that the company's strong cash flow, positive synergies and improving home construction business are not fully factored into the company valuation.

Benefits from Infastech Acquisition

The Infastech acquisition provides a complementary addition to the existing engineered fastening platform while increasing exposure to emerging geographies and broadening end market exposure. In my view, the acquisition of Infastech will have the following two major impacts:

• The acquisition will be more complementary than overlapping given Infastech's relatively lower automotive exposure (only 29% vs. 65% for Emhart) and greater micro-fastening offering (about 20% of Infastech's sales) in which Emhart does not participate. These micro-fasteners are used in electronics applications, such as smartphones (Apple is one of Infastech's largest customers).

• Infastech will also increase Stanley's exposure to Asia (which accounts for 50% of Infastech's sales vs. 26% of Emhart's sales). Stanley's pro-forma companywide exposure to emerging markets would be 16% of sales after the deal.

The deal is expected to close in 4Q12. I believe this acquisition will provide upside to both the top line and bottom line in FY13.

Potential Sale of HHI

I like the strategic rationale behind the potential sale of HHI. Although HHI has an attractive margin profile today, I believe there is a risk to the business' longer-term competitive position. Specifically, HHI competes in product categories with high price elasticity (residential locks, hardware etc). In these categories brands are not particularly important (price is more important to customers than brand) and product innovation/technology is also not an important differentiator. Thus, any further investment in this business poses a risk to margins and sales. I believe the potential sale of the HHI division business, currently being marketed, will generate well over $1 billion in after tax proceeds and help reduce the company's leverage ratios. In addition, its sale will provide enhanced flexibility for share repurchases on top of a high dividend yield. I believe that increased dividends and potential share buybacks will be received positively by investors.

Low Valuation

Danaher Corp (NYSE: DHR) and Snap-On Inc. (NYSE: SNA) are the main peers competing in some of the similar end markets; the former competes in consumer & professional hand tools, and the latter competes in the professional tool market. The following table summarizes the EPS growth (in FY13) and forward PE of Stanley, Danaher and Snap-on:

Clearly, Stanley's expected EPS growth is relatively higher among its peers, but it still trading at a discount. Stanley also offers an impressive dividend yield of 2.56% with respect to Danaher Corp's 0.18% and Snap-On's 1.85%.

Even companies in other sectors with significant residential construction exposure are trading at a premium to Stanley. For example, The Home Depot Inc. (NYSE: HD) is trading at ~50 % premium. I believe the only advantage Home Depot has over Stanley is that Home Depot, with limited international exposure, remains immune to macro headwinds while Stanley generates 30% of sales just from Europe. Even then, I believe this much of a valuation discount is not justified given similar outlook and strong dependence of both on housing strength. Therefore, I anticipate a valuation upside in the near term.

I believe the recent pullback in raw material prices will likely result in abating material inflation concerns in 2H12 and a tailwind in 2013 (steel, resin, base metals are 35% of spend). Despite a challenging macro environment, I expect growth in sales, earnings, and cash flow in 2012 and 2013 as a result of the cost and revenue synergies from the acquisition. Thus, I recommend it as a buy.

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