Stanley Black & Decker, Inc. (SWK) Earnings Call Transcript & Summary

[Audio Gap] I'm the multi-industry analyst at Barclays. It's my pleasure to have opening up the afternoon slot here. Corbin Walburger, VP of Business Development and Interim CFO at Stanley Black & Decker. And a lot of you, of course, know Dennis in the Investor Relations at Stanley. So thank you both for being here. I know there's a lot going on at Stanley these days, and it's a very busy time for you. Maybe Corbin, if you wanted to just make some sort of preparatory remarks and then we can get into the questions.

Yes. Sure. Good afternoon, everyone. As Julian said, I'm Corbin Walburger, the Interim CFO at Stanley Black & Decker, joined Stanley back in 2008 after having spent a little more than 10 years at Goldman Sachs, doing investment banking. Stanley was one of my clients. As you probably know, we've taken a lot of significant portfolio actions over the last 18 months at Stanley. We've divested the security business, divested the Oil & Gas business, and we've become a much more streamlined and focused company with some incredible franchises. The remaining portfolio now is essentially a Tools & Outdoor and an Industrial business. The Tools business is about $15.5 billion. Half of that power tools; 1/4 of that hand tools, storage and accessories; another 1/4 of outdoor products. So those are handheld products, walk behind products and Large Format mowers. Our Industrial's business is about $2.5 billion, made up of 2 components in Engineered Fastening piece that serves the automotive, aerospace and industrial markets, highly engineered products that fit into specific applications and help our customers be more productive. The infrastructure business is about a $550 million business. It's kind of got 2 pieces in attachments and a heavy-duty tool piece. We've got a collection of incredibly powerful brands, brands that we think are the best in the industries, professional brands like DeWALT. We've got CRAFTSMAN and STANLEY; consumer brands like Black & Decker. We've got specialty brands like IRWIN and LENOX and Facom and Mac tools, and we've got some great outdoor brands like CUB CADET, Troy-Bilt and HUSTLER. We're a global leader in Tools & Outdoor products. We've got the broadest product lines across multiple end markets, and the most extensive distribution network in the industry, and we're a leader in innovation. Historically, we've had a really successful operating model that has needed a refresh. I'll talk a little bit more about that in a couple of minutes. And over the last 2 years, we've seen incredible demand volatility and supply chain constraints that expose places where we really needed to transform the company. The company is guided by our purpose, which is for those who make the world. Last June when Don Allan was named CEO, he laid out a framework for the transformation that he wanted to undertake. And with the company being more streamlined, we wanted to be more efficient, we wanted to move closer to our customers, and we wanted to make some investments in places that we hadn't been investing enough in for growth. And we made great progress in 2022, and we put a very solid foundation in place. The priorities for 2023 are largely a continuation of that message, big focus on strong cash flow generation, inventory reduction, gross margin improvement on a path up to 35% plus gross margins, transforming our supply chain and gaining market share. On the fourth quarter call, we gave you all an update on the transformation. I'll mention more about that this afternoon. The kind of -- a couple of just key things I wanted to mention to before we get to the Q&A. On the inventory side, that's been a big topic of discussion. In the second half of 2022, we took out $775 million of inventory. It was an enormous amount of work, but we've actually got a goal to take out between $750 million to $1 billion of inventory out in 2023. It will be a reduction -- the reduction will be a little demand dependent, but we're targeting about $500 million of inventory in the first half. And that inventory liquidation will allow us to generate strong free cash flow. Free cash flow goals for 2023 are $500 million to $1 billion, and we'll use that cash to fund the dividend, to deleverage our balance sheet and to invest in growth. We've undertaken a pretty significant cost savings and supply chain transformation program. We saved about $200 million in costs on the SG&A side in 2022. On an annualized basis, that will be about $500 million for 2023. And on the supply chain side, we've got line of sight this year to about $500 million in savings, another $500 million in 2024 and another $500 million in 2025. So the total program will be about $2 billion in savings and about $500 million of that will be reinvested in the front end of the business around product innovation and commercial resources. The 4 key programs on the supply chain transformation are strategic sourcing. We've already saved about $40 million from the very initial start of that project. We've got 20 RFPs out right now, covering about $2 billion in spend, and those are due in mid-March. We've got a big effort in product platforming and SKU rationalization and product simplification. We've already approved 50,000 SKUs to be decommissioned. We're now having discussions with customers about how to replace a product that they're buying today with a similar product that delivers the same value. We've got a big effort that will probably be more focused in 2024 and 2025 around facility optimization and redesigning our distribution network to help us to be closer to our customers. And finally, a real emphasis on manufacturing excellence. Emphasizing Lean, we've got 4 plants that are in the program right now for Q1, we'll start Phase 2 in Q2. We'll continue to update you all on this big program, probably one of the largest initiatives that we've undertaken in the last 15 years and an enormous amount of focus and work going into it. The supply chain transformation and the cost savings programs will free up capital, but the primary reason is to allow us to be closer and more responsive for our customers. It will also allow us to free up some capital to invest in electrification, which is a big focus for us, additional innovation. And like I said, feet on the street, people in stores and more commercial and digital marketing. The company has been around for 180 years, a tremendous legacy. But today, we're a more focused company. We're a more agile company with a goal to delight our customers and end users with great products and to deliver shareholder value. And those are my prepared remarks.

Great. Thanks very much, Corbin, for that introduction. Maybe just the first question. As you said, it's been a volatile demand environment to put it politely in the last sort of 3 years. Where do we stand right now? How is that first quarter playing out on the top line, particularly as you think about Tools & Outdoor?

Yes, you bet. What's interesting is -- I would kind of put it into 2 buckets, consumer bucket and the pro bucket. The consumer for the most part has been pretty consistent since the middle of last year. We saw -- during the pandemic, we saw a big decline drop, and we saw a lot of demand. And then probably in the middle of the second quarter last year, we saw a pretty significant falloff in demand for the consumer, and that stayed fairly consistent through the course of 2022 and even into 2023. The Pro at points in time in 2022, we thought the Pro would start to weaken, but the Pro is pretty resilient throughout all of 2022 and even through the beginning of 2023. Our guidance assumes that the Pro will start to back off and weaken at some point in the second quarter. We haven't seen that yet, but that is what our expectation is. But as I said, so far, so good on the Pro.

Got it. Okay. So the sales base is kind of going sideways kind of sequentially at the moment in tools. Okay. And if you think about that Pro weakness that you mentioned, the prospective guide weakness, how do you think about sort of -- what are the parameters behind that guidance assumption because it has been strong in that channel for some years. Maybe help us understand how you sort of layered out the slope in that moderation?

Yes. Well, I would say the driver is, I think there was a big backlog. So I think a lot of us that were home during COVID decided we were going to redo a bathroom or kitchen. There -- so there was a huge spike of demand for the Pro and for the consumer. And the Pro is just -- it's taking longer for the Pro to bleed down that backlog. And that backlog still remains fairly strong. So my sense is it's probably just a general decline as that backlog subsides and probably doesn't get refilled because people are feeling a little bit of pinch in their pocket books or as we all know, have shifted some of their spending from hard goods to services. And specifically, as it relates to the scenarios that we laid out on the call, if you think about a scenario where things kind of stay like what we've been seeing today, that's more kind of the upside case. The base case assumes that the Pro does retract. We've got like a 3% to 3.5% volume decline for Tools & Outdoor programmed in for the back half of this year. That actually approximates kind of the garden variety of recession for the Pro for our business. If you look back, historically, ex the Great Recession, and then the downside case would be a little deeper versus those histories. So that's one way to frame up the scenarios and how we're thinking about planning for the year.

That's helpful. And when we're thinking about inventories in tools, I think it's hard for people in this audience and myself to understand it because it seems like you and a lot of your tools -- peers have a lot of inventory, but everyone says that the channel doesn't really have any. So sort of just help us understand kind of the confidence level in that channel inventory being okay and it's all on sort of your own books, if you like.

Yes. So I think our view of the channel right now is that they are at pretty normalized levels in inventory for us and for our products. So for us, a lot of our inventory is in DCs, it's in raw materials, it's on the water. And so it's really just a function of -- as you know, in the second half of 2022 to try to reduce that inventory, we took out really big chunks of production, about 30% of the days. And then there are also some commercial activities. And so for us, you don't want to stuff the channel. You don't want to write off a bunch of inventory. The good news about the inventory is it doesn't become obsolete, it doesn't expire, it doesn't get old. A lot of our inventory has been built in the last 12 to 18 months. So it's good inventory. And so you want to manage it in a way that's smart but also aggressive to try to get that inventory down as quickly as possible without severely impacting your pricing or your growth outlook in future years.

And on that point on price, I think the assumption is it sort of neutral in the back half. Are you seeing your peers, the other tools companies also kind of holding the line on that discipline.

Yes, it does feel like our peer set has been fairly disciplined on price. As you know, we had a lot of inflation early on. It usually takes 3 to 6 months for us to get price once we get that inflation. And so as inflation starts to subside, you want to hold on to that price even longer so that you can recoup some of that lost margin. So we've been very disciplined. Our peers have been disciplined, and our anticipation is that will carry forward in the future.

And how do we think about the sort of future state of inventory? So I guess, it's about 30% of sales today. Pre-COVID was in the teens. This year, you've got that up to $1 billion out. Sort of beyond this year, there should be more room then for working capital, cash tailwinds after 2023, is that fair?

Yes. Absolutely. It's a good question, Julian. So I said this in one of our meetings this morning. When I started, we had a big focus on working capital turns, getting to 10 working capital turns, and we actually got there. And we probably freed up about $1 billion of cash. After the Black & Decker acquisition, we did that again. So historically, we've had a target of getting to 10 working capital turns. We're nowhere close to that now. If you look at our DSI, I think at the peak of inventories last year, we got it to about 180 days -- clearly too much. At the end of the year, we were at about 160. The target for this year is 130 to 140. I think a good long-term target -- I don't know if we'll get all the way back to 10 turns. Historically, that 10 turns probably equated to about 100 days of inventory. I don't know if we'll get back to 100 because our customers have changed their patterns a little bit and rather than want product in 7 days, they want products in 24 to 48 hours. So you probably have to carry a little bit more inventory. We'll also carry a little bit more inventory as we go through the supply chain transformation and shift manufacturing around close distribution centers, consolidated distribution centers, you'll see that in '24 and '25. But as we emerge from that, I would love to get us back to 110-ish type days so that we can free up capital. We probably won't get all the way back to 10 working capital turns, but getting to 8 to 9 feels about right. And that from today, we'll also free up a lot of capital.

And when we think about free cash is in particular focus because of the leverage levels today, and the sort of heightened scrutiny on the sort of quarterly cash flow and cash balance. How should we think about the pace of that $500 million to $1 billion of cash this year.

Sure. you will probably see us have negative free cash flow in the first quarter, which is pretty typical. And then we'll have nice free cash flow in the second quarter and then in the third quarter and fourth quarter. So you typically seasonally see low working capital -- low free cash flow in the first quarter, and then it builds throughout the year. And that pattern will probably be consistent in 2023. I think one thing that will be different that we're targeting is if you think about taking the inventory levels down and making progress on that, even if there is some other seasonal factors in working capital that are typical for the business, so we want to try to make progress each quarter on inventory even with the fact that we've got big selling seasons with Outdoor and Father's Day and we will be producing some inventory for during this time period as well. And so that piece of it will be a little different from the historical trend. The other working capital categories are probably going to be consistent with historical trends, and that results in the cash profile that Corbin talked about.

That's helpful. And as we think about the sort of P&L, margin, price, net of cost, how does that driver kind of move as you go through this year?

Well, historically, we have not gotten all of our inflation covered by price. We've gotten close. And so you make up the difference in productivity. Our anticipation is that will happen again. I don't know what else you got to hit on that one.

Yes, I guess, as you think about pricing, the pricing that we've built into the plan is really related to the price increases that we put in place in Tools & Outdoor across the board in May of last year. And so you should expect that we're going to have probably not the same pricing contribution that we had in the fourth quarter because some price increases are going to roll off. But first quarter will be positive. Second quarter will have a little bit of positive and then that's really the planned price for the year related to carryover. And then cost inflation is a headwind all through the year -- is different?

For us, it's -- we've actually got net 0. So no inflation, no deflation or they really offset each other. You'll probably see some inflation in the first half of the year and a little bit of deflation in the second half of the year. We have some things like battery inputs like lithium and nickel that are still going up and then some commodities that you've started to see come down a little bit. But components in value-added products, we haven't seen a lot of deflation yet on the cost side.

Got it. But you're not dialing in any sort of big tailwind from gross cost in back half is sort of flattish...

Net zero.

And there is a dynamic here, too. When things show up, we do have to turn through the inventory, and that's another reason why the destock is important as you can't really start to see any of these types of benefits, the supply chain benefits until you really get through the destock and then turn that through inventory and you start to see the benefits from the programs.

Got it. And then you've talked about that sort of $5 of earnings number for next year. What sort of top line was that -- is that number based off?

Sure. Well, I think what Don was trying to do when we talked about that was to annualize the second half of 2023, and then also think about the fact that -- as we look at demand right now, we've kind of laid out our high, medium and low. I think it probably assumes that the middle case out into the future, you'll get benefits from the supply chain transformation that could probably push that up. But that's how we kind of thought about that number.

Yes. The only thing just to make sure to add to is the annualization includes the fact that the back half doesn't really have a lot of contribution from outdoor, where seasonally, you do get a much bigger contribution on an annual basis from the Outdoor business when it makes much of the money in the front half of the year.

Got it. Okay. So it's assuming sort of steady top line with the second half trued up for Outdoor seasonality. It's not assuming a V-shape onto revenue?

No, no. It's just, as you said, plus you start to get a little benefit from the supply chain transformation, which could help that.

Got it. And I think on the sort of Tools turnaround effort and getting market share back is often described as sort of getting closer to the channel, closer to the customer, closure to some of the big box. Maybe help us understand in sort of practical terms, what does that involve exactly? That sort of $300 million to $500 million up to $500 million of reinvestment, just sort of give us some examples or...

It's a few things. One is reformatting the distribution network so that you can hit your key retail customers in 24 to 48 hours from the time that they order. So positioning DC centers that are close enough that have enough of a range of inventory so that you can ship really quickly to those folks. From a manufacturing standpoint, we want to get to about 70% to 80% of our products that are sold in North America, produced in North America. And I guess the last piece, which is probably more of the investment side, is having more salespeople, better coverage, more people in the stores, more digital marketing, more commercial marketing resources available at the point of impact of the customer.

And maybe innovation, too.

And clearly, product innovation. I mean the customers are demanding it. We're moving as fast as we can, particularly on the Outdoor side to electrify that product line, but really across the board.

Got it. And is that sort of -- the Outdoor business, I guess, has been bulked up a lot in the last few years with MTD. Is the sort of the playbook on the turnaround in Outdoor versus tool different? Maybe give us some sense of what state the Outdoor business is in? Does it require sort of different things to be done to it than Tools?

Yes, -- it's a good question, Julian. The Outdoor margins of the businesses that we acquired are probably still in the mid- to high single digits. That whole portfolio is in much more transition than the -- maybe one tool is going from corded to cordless 25 years ago, it was there. But right now, in Outdoor, you have this massive transformation. Handheld products are already there. Walk behind mowers are moving very, very quickly. Large Format right behind that. The large -- I'm sorry, the ride-on right behind that. Large Format is probably 3 or 4 years out, that's going to be hard. But I would say the difference is that is an industry in transition from gas to electric and getting the right products as quickly as you can that are comparable from a performance standpoint is really important.

Yes. And I think as it relates to the transformation, a lot of work was done around the footprint before the business came into the portfolio, MTD was working on that independently. And if you think about our strategy going forward, it's electrification, but it's also how do you start to deliver professional products to the pro and the independent dealer network in particular. And both of those assets came with very good footprints from an independent dealer perspective. So we have great coverage. We've got the product portfolio with DeWALT and we're working to exploit that as well. And that's how you get the outdoor business from the margins that Corbin talked about up to the low double digits, then ultimately closer to that line average for Tools over the longer term.

And does that transition to electrical or the electrification of Outdoor, is that carrier sort of there's a margin dip reinvestment mix and you come back up? Like how do you -- how do we think about the impact on sort of profitability of the business?

I don't -- I personally don't think there will be a dip. I think it will be a steady improvement over time.

And the Industrial business doesn't get too much airtime, I suppose, to obvious reasons. Like what's the state of play there? There has been some portfolio cleanup that it is simpler. But is it the case that looking 5 years' time, maybe there isn't much left of it?

We have said that over time. We anticipate it being a pure-play Tools & Outdoor business. They're incredible businesses. The Engineered Fastening business is a phenomenal business, impacted negatively right now by the automotive supply chain challenges that they've had over the last couple of years, that business will rebound over the next year or 2. Aerospace in a similar way. The infrastructure business is a great business, it's kind of leveraged the infrastructure build, but also all the building that's going on around the country. So they're very good businesses. But to your point, as we think about how we actively manage the portfolio, those are the ones we talk about a lot.

Got it. And then if you think about the sort of goals of that mid-30s plus gross margin, OpEx to sales of sort of 20%, 22%, let's say, with a normalized revenue number, you get sort of earnings per share of well over 5. What's the sort of the realism or the ambition to get to those kind of $7, $8, $9, $10 of EPS?

It's real. It's a real ambition and it's really what everyone is focused on it. If you think about where we emerge at the end of the supply chain transformation in 2025, getting back to $2 billion to $2.5-plus billion of EBITDA is what the big focus is. One of the things that maybe is implied in your question is, do you try to drive towards high-teens operating margin? Or do you pull back a little bit and invest some of that in growth? And I think at the margin, we probably changed a little bit our view that we would rather take a little bit of money out of that margin and invest in organic growth to allow us to regain market share and grow 2x to 3x the market than to try to squeeze every penny out on the cost side.

And do you think that -- what do you think was sort of the industry entitlement is for sort of a well-run tools business? I feel like sort of double -- low teens, mid-teens is the right levels large players can get...

For us, it's build like that.

Perfect. Good. All right. Well, thanks very much for those answers. We'll now switch to the audience response survey. So everyone has these gray devices. The first question, do you currently own the stock? [Voting]

Some overweight, mostly not. The next question is around sort of general bias positive, negative or neutral? [Voting]

Very, very even. Next, we'll move on to through-cycle earnings growth. Now the trigger thing here is, I suppose the peer set should be against the company that this conference or sort of in broad industrial or multi-industry is the peer set, I think we're trying to use. In line with the peer set is where people's heads are at. Then I suppose excess cash is not a major topic right now.

It will change over time.

That will change over time. That's exactly right. But for the near term, it's probably debt reduction. And on that point, actually, how should we think about the dividend? Like is it safe?

Yes, I mean, look, we paid a dividend, I think, for 140 years. It is incredibly important to us. And I anticipate it will stay that way for a long time.

Perfect. That's very clear. Now this is sort of what PE multiple should stand. And well, this year it's -- yes, this year it's a challenging sort of denominator, I suppose. So we have to treat this one lightly. So people have approached that as a through cycle. I don't think people are saying 10x $1. But if people have approached it as a through-cycle PE, I suppose. The next question, this is why people don't own it or why do you think it's worth a PE of 12 and not 17 or what have you. [Voting]

So execution, a lot of work can be done there on Tools market share and so forth. The next question is around -- well, the last question, should I say, ESG. In general, it's been about 1/3 for #1 and 2/3 for #3. This is a new question this year. [Voting]

So similar to the average on that topic. Great. Well, thank you very much, Corbin and Dennis, for that discussion.