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

Okay. I think we're live. So for those of you that don't know me, I'm Nicole DeBlase. I'm Deutsche Bank's multi-industry electrical equipment and machinery analyst. Next up on today's presentation schedule is Stanley Black & Decker, and I'm pleased to introduce Pat Hallinan, EVP and CFO. Pat just joined Stanley in January 2023, prior to which, he was CFO of Fortune Brands. And also on the stage with me, we have Dennis Lange, who works in Investor Relations or heads up Investor Relations, I should say. I think Pat wants to kick things off with a few slides, and then we'll get into the fireside chat. Just FYI guys towards the end, I will open it up for questions. So please don't be shy. Go ahead, Pat.

Thank you, Nicole, and welcome, thank you for the interest. Just going to go through about 3 or 4 slides, update you on Stanley Black & Decker's journey. We've been through a big transition in the last year strategically. So talk through the strategic change to the portfolio the transformation, that's what way, which -- of which the priorities are improving margins and improving cash generation than the fuel investment and share gain activity. So get to an update on the business. For those of you who might be getting reintroduced to Stanley Black & Decker, we have streamlined the portfolio quite considerably. Last year, sold off Security and Oil & Gas. And the business is focused on 2 business segments, Tools & Outdoors that house many of the long-time brands you may be quite familiar with. The Tools & Outdoors business is a global business, just shy of $14.5 billion of revenue last year and about 85% of the revenue of the portfolio. Many of the Pro and consumer tools brands that you're very familiar with STANLEY, DEWALT, Craftsman, Black & Decker and so forth. And then in Industrial business, which also uses the STANLEY brand name, but has other brands in there as well. In Industrial business, that's about $2.5 billion in revenue or about 15% of the portfolio, really focused on 3 segments, 2 of which are fairly aligned in the sense that their fasteners business, one in automotive, one in aerospace. And then an industrials business for a set of equipment that mostly attaches to other big equipment for infrastructure projects. So 2 big segments, a much more streamlined portfolio and a much more streamlined company. As we retooled the portfolio last year, we also delayered the company and refocus the corporate infrastructure so that we have much tighter-facing to end customers, and a much more -- much leaner organization structure. And we're building this growth franchise going forward on the power of the brands, on the talent of the people that we have, on the strong innovation engine that we've had for a very long time and is still alive and well and on a set of new operating capabilities that are driving margin improvement. And so as we retooled the portfolio last year, we also kicked off a big transformation of the business in terms of its capability and its ability to drive new cost and margin performance. So here we go, transformation, which is well on the way. The objective is to get these brands back to the margin and share performance that they want and have long had and where we're trying to get the business in very short order and are well on the way to doing so is get the business to the point where it's growing about 2 to 3 the rate of market growth. And our long-term market growth trajectory is nominal GDP with a big chunk of that being U.S. nominal GDP. So think of a market over the long-term horizon of 2 to 3 percentage points of CAGR, and that has our business objective to grow about 4 to 6 percentage points, which is a long-standing growth rate of our Tools & Outdoors business, and we're getting it back to that stage on the power and innovation. The second order of business is getting the margins back. Obviously, the -- both tariffs and COVID-driven supply chain to a have really challenged us operationally and have hampered margins over the last 18 or so months. We finished last year with margins in the low 20s, but we are pointing back towards 35-plus percent gross margins, and we're well on that journey and have a very powerful transformation underway that's driving it to that level, and I'll update you on some of that progress on the next slide. And then get back to high free cash flow generation, roughly 100% conversion of net income. And then turn that margin and cash generation engine back towards share performance, leveraging innovation. And so the transformation is well underway. And if you look at what we've delivered since the back half of last year and the first quarter of this year, the first quarter of this year, we delivered $230 million of margin improvement, and that's against an objective to get by 2025, $2 billion of cost out of the enterprise, $1.5 billion out of COGS and $0.5 billion out of SG&A from a run rate basis by '25. Through the first quarter, we delivered $230 million. And if you add the run rate we generated via SG&A in the back half of last year, $430 million. The SG&A is well underway, certainly, by the back half of this year, fully into that $0.5 billion run rate on SG&A. By the end of this year, the total with COGS will be a run rate of $1 billion and then another $1 billion of COGS to come over the course of the next 2 years, '24 and '25. We also, in an effort to delever and to get back to the strong cash flow generation, this business is traditionally demonstrated working inventory down and inventory down to both delever and then invest in growth. And so we've driven $200 million of inventory out of the first quarter, which is quite an achievement because in our industry and in our business, seasonally, you're usually building inventory during the first quarter. So that's worth a $200 million net number. It's more like $400 million to $600 million gross number relative to the usual working capital flows in the first quarter. We've delivered $1 billion so far of inventory reduction since last year. And for this fiscal year, are aiming at $750 million to $1 billion in order to generate $0.5 billion to $1 billion of cash. And our objective is then to take this margin performance and cash generation and invest roughly $300 million to $500 million of it back in the business on innovation and market-facing capabilities to drive share gains, but a transformation very, very much on track. If anything, a bit ahead of track, and I think is going to be a great source of fuel for growth in the future. And with that, the last slide is just a slide illustrating that we're well on the way to unlocking what has long been the power of the business, which is innovation and the people and the brands. And we really feel like we're setting this business up to deliver great margin improvement and cash flow improvement in '23. And then as we start in '24, really putting some topspin on the top line again. So with that I'll turn it back to you for some questions.

Excellent. Thanks, Pat. So maybe we start with retail POS, both in North America and Europe. And I guess, in particular, what are you seeing with respect to Pro as well? Then I think the level of concern around Home Depot recently reduced their own comp's guidance for the full year, if that has any impact on how you guys are thinking about POS?

Yes. I would say what Depot always announces about a month after us. So we could see a lot of what's going on in our world and our part of their world before they announce. And so when we gave our guidance, we had a window into the retail POS environment. What I would say is the retail POS environment, other than the choppiness of outdoors, which I can get to in a second, but if you're really talking tools, it's kind of been relatively steady since the latter part of last year. I mean it is down from a COVID peak, but I would say that the tools business relative to our initial guidance, which was at the start of the year and the guidance we've effectively reiterated at the end of the first quarter, is very much in line with our expectations. It's not slightly better. I think among the drivers of that is U.S. new home construction and repair and remodel has been a bit stronger than people expected. So the tools POS, think of it as down low to mid-single digits, running through this first half or third of the year and relatively steady and driven by strength in the Pro and a bit of softness in the do-it-yourself consumer.

Okay.

When you think of outdoors, outdoors has been choppy with the weather in the Eastern Seaboard in the upper Midwest, which has been kind of colder and wetter in the Upper Midwest and colder in the Eastern Seaboard. The season is not over. I would say the choppiness, given the strength in tools and the level of choppiness to the outdoors, we still feel that the guidance we set at the beginning of the year and that we reiterated in the first quarter is appropriate that our top line for the year on a shipments driven sales basis will be in that low to mid-single digits down. I'd say if you go outside the U.S. because most of the geographies outside the U.S. did not have the level of fiscal stimulus from the government, it had less of a peak and a valley dynamic to it. And really, if you adjust for Russia out of the mix, which obviously we've had to kind of step back from the Russian business, that those businesses aside from the earliest parts of the year are actually in growth mode because they've kind of gotten through the cold at home. And I would say that those markets are stable. And in fact, in some parts like in Latin America, actually growing and very -- quite favorable. So I think we feel as long as the dynamic right now, which is the dynamic most consumer businesses, whether they're durables, are fast-moving or facing of Fed uncertainty, more uncertainty, supply chain healing, we kind of feel like that we're in a pretty steady state, and we're thrilled about our guidance for the year right now.

Okay. Okay. Got it. And then just going back to the outdoor point that you made, sounds like trends have kind of remained choppy through the early part of the outdoor selling season. At what point do you think you would need to consider inventory levels in the channel and outdoor?

Yes. And it's a business I'm learning. It's a seasonal business. I think that most of the inventory bets that we or the channel have made for outdoors at least for this spring summer, that the inventory bet has been made. The question is how do you monetize that inventory as you get towards the latter stage of it or do you carry it? I would say that season is not over. We've had some really, really strong weeks and we've had some soft weeks. We'll get through to the mid- to latter part of June, and then we'll have to decide together with our channel partners, how you navigate the inventory, whether that's a holdover for the next year or you do something different with that. But I -- everything is within the bounds of managing our guidance. We're -- while the season has been choppier than we would prefer, it's within the bounds of our ability to manage it and within the bounds of our guidance.

Okay. Understood. And just maybe if we could get a bit of a progress update on the inventory reduction efforts? And how you're thinking about the cadence of the rest of the year with respect to inventory reduction?

Yes. So as we said, we're aiming for $750 million to $1 billion for the year, and we're challenging ourselves to get as close to $0.5 billion for the first half. There'll be some work to do given the choppiness of the inventory or the outdoor season on that one. But we're -- we have a team that's monitoring this cross functionally week-to-week. And so we feel like we're tracking towards our full year objective. Our goal in attacking inventory is to do it via curtailment of production and curtailment of procurement as opposed to using price. So think of it as we're kind of shutting down the production engine as opposed to trying to use price to drive demand. In a durable space, first of all, if you make rash pricing decisions just to move inventory at a moment in time. There's always a danger that those pricing decisions can stick longer than you would like. And so that's a lever we're not using. And we're getting the flow-through of inventory that we expect and would like. And so the real question is, given where the macro is and given how the outdoor season plays out, what does that mean for the ramp rate of our own facilities or our vendor facilities through our production -- our procurement activities.

Okay. Very clear. So at a recent conference, Don was speaking about a preliminary 2024 framework. I think he mentioned an EPS range of like $4 to $5. In the past, STANLEY has talked about a number closer to $5. So I guess what has shifted that a bit to $4 to $5? And then if you could just remind us of the bridge to get to about $4 to $5?

Yes, I'll start, maybe Dennis can add a little bit to the latter stage of it. I think, nothing has changed. I think from a business health perspective, I think all Don was trying to signal subtly in the move from one number to a range is what will be predicated on the actual result of '24, and obviously, we'll give guidance in early '24 is what's the macro? And what's our desire to invest for growth? We have a lot of confidence in the cost structure transformation and a lot of pride in the innovation engine that is still alive and well in the business. And it will be a judgment decision of at what point in the journey do you pivot towards heavy reacceleration of share, right? And that's going to be predicated on how far we are down the cost journey and the cash journey and also the macro. And so I think, if we go to a number different than $5 for '24, it's going to be driven by those 2 things, which is what's the macro at the point in time and what is our desire to invest for growth. But we'll be judicious about the growth. We appreciate where we are. We need to get our margins up. We need to get our cash generation up. We need to delever and so we'll be balancing all of those things as we set '24. But I think all that Don was trying to convey is we now feel really good about the momentum on the cost side of the equation. At what point in time do we have to amp up the growth side of the equation, and that will affect '24?

Yes, there's some really powerful drivers that are in our control that are stacking up for next year that can help fund what Pat is talking about. If you think about being through the destock and the recovery of the gross margins from that perspective, we've got the $1 billion of cost savings that we're putting in place. There will be another $500 million next year that we'll take out of the cost of sales line. And as such, all of those factors and none of that includes if there's deflation as well. And so there's a lot of tailwinds that are stacking up and then we'll have to see kind of what Pat was flagging around the markets as well as the investment profile as we ultimately get to that point to give guidance.

Okay. Okay. Fair enough. And then I think you guys have talked about a more normalized $7 EPS number. Is the bridge to get from what we're seeing now and the expectation for 2024 to a more normalized number, is that really just about execution on the cost savings?

Yes. I mean that's the biggest factor, Nicole. I mean it's not really the cost recovery, in particular, around getting back to 35% plus gross margins is the biggest lever in our control to get back to a more normalized level of EBITDA or EPS or however you're looking at it. And I think the way that what's in our mind is there's a few stages we flagged what does the EBITDA look like on a run rate basis in the back half of the year. That's step one. Then it's getting back to those levels from 2019 and kind of getting the margin recovery to get to there, and then ultimately beyond. And so that's how we're thinking about it, and there's going to be steps to the journey, and we're trying to give you what we're seeing and where we have confidence about the cost program to get there.

Okay. Okay. Got it. Maybe moving on to the topic of pricing. So I think for the rest of the year in Tools & Outdoor, you guys are effectively embedding no further help from the pricing line. What are you seeing from a competitive perspective with respect to pricing?

Yes. We reported in Q1, 2% price, which was carryover and we're going to be roughly flat in the balance of the year. So you have that correct. I would say there's some moving parts. I mean obviously, you still have some parts of carryover, but then we'll be just more active in promo in the back half of the year, not because we're doing something special to drive the top line or inventory, it's really we're returning to seasonal promotional participation that we were unable to participate in last year because of product shortfalls. So that combined kind of gets you to that 0 the back half of the year for us.

Okay.

I would say broadly, industry-wide, when you have an environment, this is especially true in the U.S. and Europe where you have Pro strength, some consumer softness and especially consumer softness at big-ticket items, there's limited traffic to monetize. So there -- both our channel partners and the manufacturers in our space are really focused on getting paid for the work that they're doing and the brands that they have. And we have not seen a shift competitively in the pricing dynamic nor are we in a mode of we're not anxious to use price to drive our inventory out of the system. We'll just curtail production. And so I'd say the pricing dynamics are relatively stable. The one thing that changes for us is for things like the back half of the year like Black Friday and so forth, where we were product-constrained last year, we'll be more involved this year, but I wouldn't view that as a change in the pricing dynamic. I would view that as a return to normalcy.

Sure. Makes sense. The cost side of the equation, are there aspects of your input costs where you have started to see relief? And is that kind of factored into guidance for the rest of the year?

Well, for the year '23, our guidance and our plan all along anticipated logistics savings. And so we are seeing that, but that was kind of in the guidance we always had from the initial output of the guidance. And that's dominated by ocean freight, which I think has kind of been broadly publicized of container rates coming way down. We started to see that in the latter part of last year and bake that into our plan and our guidance. I'd see you're just now starting to see some metals and resins waiver, but it's just starting to happen. And the way our procurement works is it has to happen to a certain degree and sustain that way. Before -- first of all, we start to see it in our purchasing invoices. And then it goes on to our balance sheet for roughly 6 months. So if things keep trending the way they're trending, I think that's a favorable dynamic but something that goes on to the balance sheet this year and affects '24. I don't think there's a big -- since the year started or since we've reiterated guidance in Q1, I don't think there's a big change to the commodities dynamic.

Yes. Okay. Can we talk about market share a bit? So how the market share for you guys have trended over the past 2 to 3 years within the key categories of handhelds, power tools maybe some outdoor conversation too? And where you see the greatest near-term opportunity for share regain in the years to come?

Yes, I'll start and then Dennis, who's been on more of the journey than I have. I mean, certainly, as we started to have component availability and therefore, product availability issues late '21 to a part of '22, especially as it pulled us out-of-aisle placement in retailers. We definitely took a share hit in that dynamic. Placement matters in all consumer categories and we weren't placed as prolifically as we traditionally were. And so we had definitely some challenges in that space. And our focus going forward is let's drive recovery of share through innovation and through brand strength. We're not just going to go chase and buy share back. I think that's -- it's not good for our investors and it doesn't set up a long -- the right long-term dynamic in the industry. I think as I am learning the business, I'm about 9 weeks in, I think while we certainly had some supply chain issues for a period of time, more broadly with maybe the exception of one competitor having maybe a bit more inventory to play with than we did, more broadly, we were probably better than average over the totality of the tariff and COVID environment. And so I feel like from what -- the data I have seen, we've tracked relatively well across the '17 to '23 time frame with the exception of especially North American retail over about a 12-month period. But we're going to earn that back through innovation. I don't know if there are things that you would...

No, I think you had -- the history is absolutely right. And then if you think about the opportunities since the opposite we're kind of talking through, it's get the placement back, feed the innovation machine. It's already strong. Last year, R&D was up 25%. It's the highest level we've ever been as a company. We want to put more back behind that. We want to accelerate electrification. And then it's about activating our strong brands and strong innovation in the marketplace in a much bigger way. And so that, we see as the biggest opportunity for us to really pull the innovation through get it to market, get it through our retailers and out to the end users and have them know how powerful our innovation is.

And do you think that the placement issue has started to rectify itself? Or is this something more of a focus for like 24 once we get beyond the inventory clearing dynamic in the factories?

Yes. I would -- and Dennis can speak more specifically, right? So -- and it's not just the big retailers that everybody is familiar within the room, but even some of our commercial and industrial trade customers placement can matter. And they tend to set their planograms 6 to 12 months out. So as soon as you start having issues or they lose faith in your ability to fulfill. It takes a while to get it back. But I -- we're -- by the back half of the second quarter, like think of it as Father's Day, from that point forward, we're not fully back to our placement by the end -- by Black Friday, we'll be kind of back to, call it, traditional placement and traditional promotional activity. And that lag time is really driven by, first, your channel partners have to have the faith in your supply chain, and then it takes 6-plus months to work into their planograms. And so that's the timing effect of it. But I think by the back part of the second quarter, we're well on our way to being healed. And by Black Friday, we're kind of fully there.

Okay. Okay. Got it. Great. you guys have been on a journey of localizing production more in North America for some time now. Where do you think you are in that journey? And end state what percentage of North America sales will be produced in North America versus where you are today?

I don't know, you could speak to some of the percentage perhaps, but I'll start off with -- we certainly want to have a resilient localized production and sourcing base. And that is going to be getting to be more North America for North America-centric. There are some things that can and are being moved quickly, whether they are part of the value chain or a supplier is part of the value chain. But it's a modest part of the equation because moving big chunks of it, it's the whole community of where are the engineering resources, where are the complementary suppliers, where is the expertise. And so we're well on the way to the modest part that can move with some pace. And then we ourselves are expanding our capabilities in Mexico. And we have a great team in China. And the strength of it, the -- one of the gating factors of moving it is less of the capacity to make stuff and it's more of the engineering talent that is part of that process. And so the gating part of how you move things whether it's back to the United States or to Mexico for the U.S. and Canadian market is at what rate can you ramp up the engineering talent and some of the complementary supplier talent, but I don't know if you...

Yes, I mean I guess the best way to think about the numbers piece of it is we started all of this kind of pretariffs, about half of our production was in North America for North America. We probably made about -- I mean -- and there's production curtailments now and everything else. So this is directionally right. probably about 10 points of a shift that we've made. But we'd like to get another 10 to 15 points on top of that as we start to fill out these facilities. And that's finished assembly. And so that's kind of in the supply chain transformation plan that we have laid out. And then from there, it's doing what Pat said and making sure we have the supplier base that's around it as well.

Okay. Okay. Got it. We have about 6 minutes left. Any questions from the audience before I continue? Okay. I'll keep going. So tools and outdoor margins peaked at 18%, actually 18% plus in 2020, but that was clearly during a very, very robust period of demand post-COVID. Is it unreasonable to that you could ever get back there? Like how do you think about the longer-term picture for Tools & Outdoor?

Yes. I think if you think about what we're communicating around this plan, what we're looking to do is to put more investment into the front end of the business. And so where we were talking about kind of pushing tool margins in the mid-teens and then going to the high teens. I think today, we're talking more about kind of a mid-teen framework. I think about what we're trying to do with the business. And so that -- as we recover, that's kind of the target, particularly around the next 3 years as we take cost out, put investments back in the business and get faster growth.

Okay. Okay. Got it. I do want to ask a couple of questions about industrial, but maybe one more on just the overall cost reduction goal, can we talk about progress that you're making? And if it's maybe going to plan, maybe a little bit faster than planned in the major categories?

It's at least at, if not ahead of plan. I would say the things that often move quickly, things like strategic sourcing are moving quickly, and that's kind of where you can get ahead of plan. And it's been helpful that kind of the global competitive environment is as the globe raised some capacity to bear during the COVID uptick, now that's a good backdrop to be doing strategic sourcing. And so that's going ahead of plan. And then we're into, I'd say, the more executionally intricate phases of it, which are SKU reduction where we don't want to lose revenue as we do that. So the governing factor on SKU reduction is how do you talk to your customers about swapping SKUs. Then we are -- we -- the company has been built through a series of acquisitions and facilities came with those acquisitions. And you would have facilities with similar process streams and similar products coming out in the back of the factory. We're now rationalizing the number of our facilities and creating centers of excellence so that we don't have unnecessary duplication or excess capacity. And those things are moving very much according to pace. But they will be governed a little bit by the execution of how do you shift without disrupting your customers. And so I am very confident, will be at or ahead of pace, but we're getting into the part of the journey that is governed by customer service a bit more so than something like strategic sourcing.

Sure. Okay. Okay. Got it. On the portfolio, so a lot of change over the past several years. Is this the end state? Or is there more to do? And I think there was a Bloomberg headline last week suggesting that you guys were thinking about maybe in action with the attachment tools business. So if you care to comment on that and just the overall portfolio construction.

Yes. I'll say a few things, maybe Dennis will add. We're focused on value creation. And getting to the appropriate level of focus to drive that value creation. And so given that backdrop, we often asked ourselves what's the role of industrials and where does it fit in the portfolio? And I -- we still feel like there's value to unlock there. And so we're not in a state of we've made a definitive decision and are going down a path. We also do need to delever. And there are some things that are further along their value creation journey than others. And so we, in the desire to delever and become more focused, we may act on some assets in the relatively short term. But I would say, the industrial business is benefiting from the transformation that we have underway in the tools business. And we'll make the value-creating appropriate decisions as both those businesses evolve and the market -- the credit market unfolds. I don't know if there's anything you'd add to that?

The only other thing I'd point out is we kind of think of industrial as 3 businesses. There's the attachment tools business. There's kind of the traditional automotive and industrial-engineered fastening. And then there's kind of an aerospace component that Pat talked about earlier.

Okay. Last question, actually, let me see anything from the audience before I ask my final question. Okay. So let's fast-forward to you guys are through the inventory reduction focus. You're kind of returning to a more normal level of EBITDA and earnings, and therefore, leverage comes down. Does STANLEY go back to its prior ways of being a very acquisitive company? Or do you kind of think of this as we have a really complete tools and outdoor portfolio and maybe we will be less acquisitive on the other side?

I would just say the M&A agenda that would likely come out of the 25-plus horizon is more likely to be -- are there ways we could take the platform we're building now around cost structure and channel access and field sales of service and support and some of the really great capabilities we have around innovation. And if there's things we can plug into that and unlock special synergies, I would say those are going to be very much things that we will look at, at that moment in time when we have the platform and the balance sheet. I think it's very unlikely that we would go down a road where we're getting more diffused and more diversified. I'd say that, that is not the likely scenario.

Makes sense. Okay. Perfect. Well, Pat, Dennis, thank you so much for your time today, and thanks for coming to the conference.

Thank you.

Thanks, Nicole.