Philippine Markets Daily

This industrial powerhouse formed over a decade ago continues to grow its portfolio through innovation, building Uniform ROAs 5x what is reported

May 20, 2021

Two companies that have been around for more than a century merged to form an industrial powerhouse that continues to stay strong today through its strategic acquisitions and commitment to innovation.

While as-reported data suggests the merger was not favorable to the combined company’s overall profitability, Uniform Accounting shows that the increased scale of the merger has actually helped generate robust Uniform ROAs of more than 20%.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Thursday Uniform Earnings Tearsheets – Global Focus
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Industries are generally classified under five stages of their life cycle—from the time one is introduced into the market and to its eventual decline. In between, an industry will reach a point where it will fail to generate significant growth because the market is already saturated with competitors.

As a result, industries move into what is known as a consolidation phase. This stage is characterized by companies engaging in mergers and acquisitions (M&A).

One industry that has been consolidating for the past few decades is in the industrials sector, which has experienced the most number of acquisitions since 1985, with at least 126,000 conducted acquisitions since then.

Companies engage in M&A activities for a number of reasons, such as to:

  • Access new markets and distribution channels
  • Achieve significant cost reductions and eliminate redundancies
  • Reduce competition and gain market share
  • Expand their portfolio of products and services
  • Increase top-line growth

Stanley Works, a global supplier of hands tools and security products, services, and solutions, had these synergies in mind when it merged with Black & Decker, a global manufacturer of power tools and security hardware, in 2010.

The resulting diversified company Stanley Black & Decker (SWK) gained exposure to different product categories and increased its global reach, with a stronger penetration in emerging markets. The company was also able to enhance its financial strength with its larger scale and better profit margins.

The increase in scale, in particular, has helped the company employ a growth strategy that involves diversifying across various industries and geographies through acquisitions, and by committing heavily to innovation.

Stanley Black & Decker has spent over $10.1 billion in acquisitions since 2002 and has engaged in 100 acquisition integrations over the past 15 years. The company has built a comprehensive portfolio of iconic and trusted brands, including Irwin, Bostitch, Lenox, Craftsman, Black+Decker, and Stanley.

The company has also been able to manufacture more than 1,000 new products every year, which is made possible through its robust innovation ecosystem.

Apart from its in-house R&D efforts, Stanley Black & Decker invests venture capital in other firms through its Stanley Ventures division, with breakthrough teams dedicated to innovation across its global hubs.

Some of the firm’s innovations include the portable power tool, the retractable tape measure, the handheld vacuum, and the first battery system that can change voltage.

A disciplined approach to making smart acquisitions, as well as a dedication to consistent innovation, has allowed Stanley Black & Decker to become the world’s largest tools and storage company.

More than that, Stanley Black & Decker is the world’s second-largest commercial electronic security business, a global leader in engineered fastening, and the largest supplier of power-driven hand tools, with a market share of 21% in 2019, followed by its biggest rival, Bosch with only 15% of the market.

That being said, analysts who look at Stanley Black & Decker’s as-reported financials would think the company has not benefited from its 2010 merger at all. It would look like the merger was not synergistic for the firm, with return on assets (ROA) that has fallen from pre-acquisition levels of 7% to levels of around 5% currently.

In reality, the company’s success is portrayed more accurately by Uniform Accounting, with Uniform ROAs that have been above 22% since 2010, more than 5x the as reported.

The distortion between Uniform and as-reported ROAs comes from as-reported metrics failing to consider the amount of goodwill on Stanley Black & Decker’s balance sheet. In recent years, goodwill sits at about $10 billion or around half of its total assets, stemming from the company’s acquisitions.

Goodwill is an intangible asset that is purely accounting-based and unrepresentative of the company’s actual operating performance. When as-reported accounting includes this in a company’s balance sheet, it creates an artificially inflated asset base.

As a result, as-reported ROAs are not capturing the strength of Stanley Black & Decker’s earning power. Adjusting for goodwill, we can see that the company isn’t actually performing poorly. In fact, it has been the complete opposite, with returns that are nearly 2x-7x greater.

Stanley Black & Decker is actually significantly more robust than you think it is

As-reported metrics distort the market’s perception of the firm’s recent profitability. If you were to just look at as-reported ROA, you would think the company is a much weaker business than real economic metrics highlight.

Stanley Black & Decker’s Uniform ROA has actually been higher than its as-reported ROA in the past sixteen years. For example, Uniform ROA was at 27% in 2020, while as-reported ROA was only at 5%.

Specifically, Stanley Black & Decker’s Uniform ROA has ranged from 15%-29% in the past sixteen years while as-reported ROA has ranged from only 4%-8% levels in the same timeframe.

Uniform ROA improved from 15% in 2005 to 19% levels in 2007-2008, before compressing to 17% in 2009 and rising to 28% in 2015. Then, Uniform ROA faded to 25% in 2016, before reaching a peak of 29% in 2019 and stabilizing at 27% in 2020.

Stanley Black & Decker’s Uniform earnings margin is weaker than you think, but its Uniform asset turns make up for it

Overall improvements in Uniform ROA have been driven primarily by expanding Uniform asset turns and to a lesser extent, trends in Uniform earnings margin.

Uniform turns gradually expanded from 1.5x in 2005 to 2.3x-2.4x levels in 2011-2019, excluding a 2.2x underperformance in 2016, before compressing to 2.1x in 2020.

Meanwhile, Uniform margins sustained at 10%-11% levels from 2005-2009, before jumping to 13% in 2010 and fading to 11%-12% levels in 2011-2019. Then, Uniform margins rose back to 13% in 2020.

At current valuations, the market is pricing in expectations for continued improvements in Uniform turns and for continued stability in Uniform margins.

SUMMARY and Stanley Black & Decker, Inc. Tearsheet

As the Uniform Accounting tearsheet for Stanley Black & Decker, Inc. (SWK:USA) highlights, the Uniform P/E trades at 21.1x, which is below the global corporate average of 23.7x but above its historical Uniform P/E of 18.2x.

Low P/Es require low EPS growth to sustain them. In the case of Stanley Black & Decker, the company has recently shown a 14% Uniform EPS growth.

Wall Street analysts provide stock and valuation recommendations that provide very poor guidance or insight in general. 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 a 6% and 9% EPS growth in 2021 and 2022, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Stanley Black & Decker’s $216 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow by 3% per year over the next three years. What Wall Street analysts expect for Stanley Black & Decker’s earnings growth is above what the current stock market valuation requires through 2022.

Furthermore, the company’s earning power is 5x the corporate average. Also, cash flows and cash on hand are almost 3x higher than its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals a low credit and dividend risk.

To conclude, Stanley Black & Decker’s Uniform earnings growth is below its peer averages, and the company is also trading below average peer valuations.

About the Philippine Markets Daily
“Thursday Uniform Earnings Tearsheets – Global Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Thursday, we focus on one multinational company that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform earnings tearsheet on a multinational company interesting and insightful.

Stay tuned for next week’s multinational company highlight!

Regards,

Angelica Lim
Research Director
Philippine Markets Daily
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