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

Great. Thanks, everyone, for being here. It's my pleasure to have next Stanley Black & Decker; Patrick Hallinan, CFO; and Dennis Lange, Investor Relations. So thanks very much, Pat and Dennis, being here. I'm not sure if you wanted to make some introductory remarks -- yes.

I'll start out with a few things and then turn it over to you for questions, Julian. But thank you for the interest. Those of you who followed us of late, obviously, we're on a journey of recovering our margins and growth post some COVID disruption. Last year, our focus was really on gross profit margin recovery, cash generation and starting to plant the seeds of growth investment, and those were all the things we executed on last year. We hit our gross margin target, actually finished the back half a bit stronger than we expected. And we generated $850 million of cash and used a good portion to de-lever, and we made $125 million of growth investments. And this year, we have a very similar focus. Until we get our gross margin back up to a traditional level of 35-plus percent, we're going to stay very focused on getting our gross margin up to a level that could sustain innovation, brand building and investment in talent where we need to and stay focused on generating cash to de-lever. But we're also going to continue to plant some growth investments, and we're going to invest about $100 million this year in innovation and field resources and brand building. So we're pretty proud of what we delivered with a tough macro in '23, and '24 is an important year of showing continued progress. But I'd say it's for the longer-term journey to return Stanley Black & Decker to above-market growth, which would be kind of mid-single digits or better top line growth and a 35-plus percent gross profit margins, with cash conversion that's high, around 100%, plus or minus 10 points, depending on what we're investing in. But that's our focus, and we're well down that path. And we continue to make progress at the trajectory we expect in a tough macro, which I think '24 will be another tough macro.

Great. And so you mentioned at the sort of tough macro for the year, and that's obviously embedded in your guide already. Maybe just any sort of point of -- how is the year starting out in terms of, yes, there's the interplay of your own inventory reduction needs then the sort of point of sale, something else. How are those 2 things at present?

Well, I'll talk about, first, demand and then how did that relate to our top line because of 2 important moving parts. I'd say that all of last year '23 was probably about 400 basis points softer than our opening guidance for '23 in our annual plan. Now much of that was baked in updated guidance throughout the year. We're probably a little bit softer at the finish on a revenue base of about $15.5 billion for the full year. We are maybe about $100 million softer in the whole fourth quarter than we would have expected. I'd say the start of this year, it's always in durables, especially home-centric durables. It's tough to read until you get the full spring season. But I wouldn't say it's gotten any better or any worse since the fourth quarter. It's kind of started with a soft DIY, especially at high price points in outdoor, and a strong pro. And I'd say in our industrial business, strength in aerospace and EV automotive and smart storage, which is also very linked to defense like aerospace is, has persisted in general industrial softness. So I would say the start of the year feels like the end of the year, the end of '23. I'd say as it relates to sales, in most of our businesses, the channels have adjusted their inventory during '23 or earlier. There's a few exceptions that I'll touch on. So for the most part, we feel like we're through most of any de-stocking. So sales in '23 were a little bit behind POS in '23. We don't see big things like that on the horizon. There's a few pockets like in independent dealers of outdoor equipment, where you could see some more of that, and in some parts of the inventory chain that supplies general industrial fastening, but not big magnitudes of things. So I think right now, our sales line should be moving in pretty close lockstep with POS. Maybe not perfectly, but they shouldn't be big gaps between the 2.

Understood. And when you think about that sort of consumer aspect because you said sort of soft DIY, strong pro, how is kind of pricing holding up? People were concerned the third quarter seems softer or firmer again, fourth...

Yes. I'd break it into a few things. I'd say, one, if you just talk about manufacturer competitive dynamics, I've seen good discipline. I suspect all of us would like our margins to be better, and all of us would like to find more money to invest for long-term growth. And so I'd say manufacturing pricing has been very disciplined, and we don't see those dynamics breaking down. There's no indication that it certainly didn't happen last year, not even the back half of last year, and it's not changing right now even with everybody having a bit more inventory than they would like. They're not using price to move inventory. They tend to be adjusting capacity to move inventory. I would say there's not big changes in inflation/deflation in our space. So there's not a driving force from inflation/deflation. And so we see pricing being steady, and we're going to be very -- our objective this year is to be very disciplined. And because we haven't seen deflation rear its head in a big way or because our margins are where we like them to be, we have pretty firm ground with our channel partners to stay on that. I would say it's going to be interesting if the big boxes, not just in the U.S. but elsewhere, get deep into a second year of another negative year does something change. I mean that's where I have my eye more on a manufacturer dynamic. But right now, pricing is pretty steady. And if it ebbs and flows in our quarters, that's just mix and promo volumes relative to normal cadence.

And how about your sort of market share perspective in say Tools & Outdoor? It feels that outdoor, you've been performing a little bit lower than some peers. Tools, very much in line.

Yes. I would say reasonable observations. Outdoor is always a little bit more difficult because everybody has very different market exposures when you look at the peers. I think we're all feeling our own pain, and the pain is in a similar order of magnitude in outdoor as you get a post-COVID rebalance. But when I was at tools, by far and away, our biggest brand is DEWALT, which competes globally and it competes in all noteworthy channels. DEWALT had a very good year. You look at the POS we can collect globally for DEWALT, it's about flat revenue, right? And that -- you heard Depot report their full year earnings, and that's a very respectable performance. I know there's sometimes another competitor out there who's above that. But relative to market, DEWALT is still performing well relative to the market. We have some other tool brands that are very DIY-centric and very retail-centric, where we need to work with ourselves and with our channel partners to improve their performance brands like CRAFTSMAN and STANLEY. And so I think that's the mix of results you would see in our tools business. I would say in outdoors, when we look at outdoors, I don't think we feel like it's really a market share issue. It's a high price point. Back to our portfolio, it's a high-price point, gas write-on component, which has been what I think some of where some of the most extreme pain is. If you look at our handheld battery outdoor growth, it's been very, very strong with double digit and very good margins. So I think we're going to have to find the base in COVID. And so our job as stewards of brands and investor returns is we're going to have to probably do more capacity takeout in outdoor and more SG&A right-sizing in outdoor to kind of get that business rebalanced for the current demand profile.

Got it. And when you think about the sort of SKU reduction program, how is that affecting your shared shelf space, that type of thing?

Yes. It's a valid question because we keep -- throughout the year, I think when I joined in April, we were around 50 -- 45,000, 50,000. By the middle of the year, it was around 70,000. And we probably were around 85,000 SKUs identified with -- at this company, if I'm wrong, maybe a little bit, about 40,000 or 50,000 out -- at least out of production. I will tell you, doing that is important work for de-cluttering the environment and enabling the footprint change and the sourcing change and optimizing in-plant performance. But it has not been a big driver of share or sales. Most of us who've been in the business, if a general manager has a reason to complain, they will complain. And when they come in and talk about their sales, they're not pointing to SKU reduction as one of the issues, right? It's usually high-price point goods, DIY-centric goods, outdoor goods have better headwind.

Yes. So that sort of $50 million-ish dollar number still seems right.

That would be if we lost it all. That has not been the case. That is not -- I wouldn't say you could point in any material way to the finish of '23 and point to SKU reduction being somehow responsible for a T&O full year of sales performance that was roughly down [ 7% ] organically. There's not some meaningful SKU rationalization driver of that.

Got it. And when we think about kind of the pace of Stanley's own inventory, how quickly or when does that get back to that? It's mid-teens as a share of sales pre-COVID. Maybe you'll run at a bit higher than that for a -- because some time. But how quickly do we get down from the current level?

Yes. I think on a days basis, pre-outdoors, we were more like in the 110-ish range pre-outdoors and pre-CAM. It's that aerospace business. We might end up more like 115, 120-ish or thereabouts. But I think we're still 2 to 2-and-a-fraction years away from that. And it's not for want to get there or knowing what to do to get there. It's really our inventory right now. If sales stayed flat, it would be about $1 billion more inventory dollars than we would like. But it's disproportionately concentrated in batteries, in all manner of electrical components, in outdoor and especially outdoor that supports independent retailers. And so we probably calculate that $400 million to $500 million every 12 months. So if we can get $500 million done in 2 years, that gets us through it in 2 years. If it's $400 million, it's 2 and a slight fraction. But it's really because given the contracts we have with our battery and electrical suppliers and given the pace you can move outdoor equipment while staying pricing disciplined, it's kind of that pace. And that excess was not spread across all product categories and brands. Most of the other product categories and brands are pretty much where you would like them. And most of our channel partners, except for some of the independent retailers in outdoor and some general industrial fastener customers, their inventories are pretty lean as well. And so it's not a broad-based dynamic we're solving for.

And when we think about kind of the cadence of earnings through this year, I think you were quite explicit about sort of first quarter. How do we think about that ramp of earnings post that? And I realize there's some sort of dynamics of EBITDA and then the below-the-line moving about.

Yes. Well, there's multiple moving parts. I mean we finished the back half of '23 with a gross profit margin around 28.7% was the average for the back half. We expect to make progress on that margin percentage in the first half, probably in the 25 or 30 to 50 basis point range. And we expect some seasonality or return to start getting some normal seasonality, where Q2 revenues become kind of if not the highest, certainly among the higher revenue quarters. And so when you look at revenue times a 29-ish percent margin, you're going to end up with pretty good EPS growth year-over-year, but that's because the front half of '23 was underwater. And then the back half of our year in '24, we're going to have some more traditional seasonality around the fourth quarter, so a little bit lower revenue. But that's when we expect to have kind of disproportionate margin performance. And so especially around the fourth quarter, we're going to be in the low 30s. So those are going to be the things that drive it. But I -- I'm sure '24, like the last 5 or so years, will be dynamic. When you're talking one of our quarters being in a fraction $1 billion of revenue in total, you're talking any one quarter can be moving at 1 or 2 points variance across the quarter. And you're kind of talking a 29% or a low 29% average gross margin for the front half and then most of the gross margin expansion coming in the back half. And that's kind of how I'd be thinking about -- and I would guess, [ the cadence ], we're going to be maybe a bit conservative on SG&A absolute dollars in the back half of the year, but again, somewhat flattish throughout the year just because we were exceptionally conservative at the back of last year, right? I think most of our year is going to be bopping around the 21-ish percent plus or minus, a fractional percentage point in any given quarter. And I think that's going to be the quarter. I think the tax rate is going to be what drives the EPS number a bit more dramatically, and that is some of our planning is going to be very back half weighted. We're guiding a 10% adjusted [ tech ETR ] for the year, but it's going to be more like in the low, mid-20s the front half of the year.

Got it. So second quarter versus the first on the sort of sales and margins, not that different. The sales step up a little with some leverage...

Yes, with that. Yes.

And where are we on sort of outdoor? The -- in the steep drop off a very inflated base, when do you sort of see that start to improve? And then the inventory, it seems very -- so that's 3 years to get rid of.

Yes. I think because the decline and reset post the COVID peak has been so significant, even in a place where you've taken price, it's probably going to wind up at least a quarter or thereabouts, if not more. And that's on a revenue basis, right? It's more on a volume basis. We're going to have to reset the cost structure for that. Yes, I think where we are right now is certainly the pace of deceleration has slowed quite considerably. But you can imagine after the Q3 in '21, after 3 years of challenges, the channel is incredibly skittish right now. So where the channel is in that business is they're only going to take inventory once they see the velocity in their environment pick up, which it hasn't yet picked up. So we're going to control what we can control this year, which is we're going to right-size the cost structure, both the physical capacity we have and the SG&A, and really focus on where do we have the most right to win. And that's more of a geography and product line breadth question for us. And I expect we'll be through it in '24, but I don't expect that -- it would be a pleasant surprise if '24 suddenly turns into a growth year in outdoor. That would be an inflection that hasn't yet occurred.

And how do you think about sort of -- as you said, the sales had a big bounce with very long drawdown. Where do margins sit versus that segment average? What's the sort of entitlement medium term?

Yes. I will tell you, we're targeted on trying to get that to be -- it's probably never going to be at the level of a DEWALT power tools. And so if you have a segment that's going to be averaging 35-plus, it's certainly going to be below that. We'd like to get it around 30%. Whether we can is going to be because the pace of electrification has been different than we would have thought and the breadth of the electrification penetration, so we're revisiting that. But I think it's a big -- this is a big year with Chris Nelson onboard running that business of outlining the future of that business because we -- I don't want to say our progress in tools is done. We've made a ton of progress in tools and less progress on outdoors. And we need that business to be able to grow better than market, and we need that business to be at, at least a 30-plus. I don't want to say that that's our final answer but at that range. Otherwise, you get a challenge, how are we going to allocate resources in our portfolio at that point, right? And so that's our focus. And I think this year is going to be a big year as again, tools isn't done, but we can afford a bit more brain power to be diverted to that focus and also doing it under the light of the current volume load.

And in terms of cost reduction, what's the sort of satisfaction with the progress, particularly versus the revenue line? And at what point would you have to think about, okay, do we need to extend the plan if revenues are not doing it?

We're trying to not do that. I mean, I will say, honestly, it was a challenge. And as you know, the program is lined out, if you haven't been following us closely, it's at $2 billion by 2025 -- by the end of 2025. $1.5 billion of which is COGS related, so we've done the SG&A part. We've done about $850 million plus, $900 million-ish in the COGS part in there or thereabouts. The progress that we lined out wasn't ever predicated, that $1.5 billion, on a big leverage lift inside the facilities and also wasn't predicated on a big volume decline. And we saw volumes last year that were about 400 basis points lower than the original transformation plan, and our guide this year at 0 is about 400, 500 basis points below our original transformation plan. So we are pulling savings initiatives forward to deliver the same dollars in the same time frame. And we did that successfully in '23. We'll have to do that again in '24 to deliver the full $500 million of '24. We expect to do that. And it will challenge it, Julian, but we feel like we have a pathway to it, and we don't anticipate changing that 35% by Q4 in 2025. Obviously, if the macro changed materially down further, then we might have to revisit that. But that's not where we're at right now.

And reinvestment wise, as you said, I think it's sort of $125 million last year, $100 million this year. Is that a -- sort of different parts I want to get into. The run rate, because if the sales recover, there should be more reinvestment. But do we assume there's another sort of 100-plus next year? And then after that, we may be in a steady state?

Yes. No, I'd say obviously, the rate at which we can get a macro that drives volume, the pace of our gross margin and our cash conversion governs that. But what I would say is there's certainly $100 million, if not more than $100 million, in the next couple of years. But if you're trying to target -- I've been a little bit reticent to say what should be the SG&A as a percentage in that sale because overall history has kind of moved anywhere from 19%, if not lower than 19%, to over 22%. And obviously, because of our performance volatility it's moved around quite a bit. This year, it would be like 21%, 22%, unless the macros start to speed up greatly, I would say. I would be, as a CFO, pricing for the long term to at least 21%, until the macro really lifted. And the reason for that is I do see a long term. We have a big-time right to win. But we need to reenergize our innovation and our brand building. And so if you're putting something in a model, I'd be modeling in the range of 20% to 21% medium term, and I don't know that we'll go below that in the future. It will depend on -- are we getting returns for our innovation? Are we getting returns on our brand building? Because if we are and we're able to realize good price, I don't know that we need to go back down to the teams to drive our returns and make a matrix for investors that are attractive. I'd rather get our team excited about innovating and realizing parts capture.

Got it. And when we think sort of medium-term earnings power, any sort of impressions there now we're getting on for sort of 18 months into the existing plan?

Yes. When I started, I was already living with '24 guidance, so I'm going to avoid giving myself '25 guidance. But what I would tell you, as a leadership team, while we were focused on gross margin and cash right now because it's what gives us the fuel to invest in our business and de-lever, our long-term objective is greater than 35% gross margin, so EBITDA margin sort of high -- mid-to-high teens, and can we get ROIC back to kind of the high teens or better. And that's our objective. I don't think that is all going to come to fruition in '25 and maybe not even in '26. But when the leadership team gets together and says, where are we pointing to on a 5-plus-year basis, at the -- and therefore, when we look through the lens of what should be in our portfolio and what should we be allocating resources and investment units, are there things that can fit into that profile?

Understood. And then so about the high single-digit EPS dollar number is, yes, sort of a couple of years type of framework.

Yes.

And then free cash flow dollar-wise, last year was a very good year because of working capital liquidation. This year, less of a working cap tailwind but EBITDA recovering somewhat. I was thinking about sort of free cash flow. After this, you've got another year of work on tailwinds, EBITDA improvement. So just dollar-wise, is this a reasonable sort of free cash flow rate at $700 million, $800 million a year?

Yes. I mean next year though, '25 that is, it should step up with EBITDA growth because you'll -- the dynamics as we move from '23 to '24 on cash is EBITDA recovery is about sufficient to offset a lower working capital reduction. Last year, we reduced working capital roughly $1 billion. This [ year ] would be $400 million, $500 million. [ It would kind of help me at that interval ]. Cash is at -- free cash flow is about $150 million lower in '24 but only 2 drivers, higher CapEx as we do footprint changes and higher cash transformation [ in the ] footprint changes. As we head into '25, you have basically a [ light ] working capital reduction, so no doubt that even by that, we should have lower cash-oriented restructuring targets and then EBITDA growth. So I think the cash next year '25 effectively grows roughly around the contribution margin, which you could think of as something approximate to gross margin, somewhere in the 30% and 40-something percent range with volume growth.

Got it. Okay. Look, yes, so your cash conversion is -- it's improving next year.

Correct, yes.

Less restructuring. Okay, yes.

Because we'll also be -- we're going to be -- in order to maximize de-leverage, we'll be bringing the whole CapEx constant, '24 to '25, if not a bit better than that.

Yes. And then leverage past -- last very quick question -- slope of...

I mean, organically, you're looking at $300 million to $400 million a year down of debt reduction. So we sold an infrastructure business. We'll get net proceeds somewhere north above [ 7% ] if you do that math, and we'll use all that to pay down debt. We may do some other modestly sized M&A. But I think if you put that aside because we can't control if and when that happens perfectly, we probably finish '24 at about a little above 4x with Moody's and a little bit below 4x with Fitch and S&P. And then we're probably a full turn better than that the next year.

Perfect. And then I think we have to turn quickly to audience response. So for any questions, if you could grab those gray boxes. First question, [ you've kind of known ] Stanley. [Voting]

So a lot of opportunity there. Number 2 is around sort of current bias or predisposition towards the name. [Voting]

Generally positive. Third one is around the earnings growth. And the peer set here, at least for this context, is sort of multi-industry companies. [Voting]

So sort of below the group average. Next question is around excess cash. You've seen some small sort of scope of the discussion for now. [Voting]

Yes. So debt reduction. Next one is around valuation. So what's the sort of year 1 PE? Obviously, the E is depressed. [Voting]

So a real broad range there, broader than normal. And the final question, kind of what's the key gating factor like why don't people own more of their shares? [Voting]

So a broad swathe on that front, mostly margins. Well, with that, thanks so much, Pat and Dennis.

No. Thank you.

Thank you. Appreciate you joining us here.