1. Is the company undervalued?
EV/EBIT: 16.59
EV/Sales: 1.53
Price/Book: 1.66
$SWK trades around a market multiple, while growing at a nice clip and returning significant capital back to shareholders. With that said there are near term issues which are expected to bring down profitability over the next few quarters. This opens up an opportunity for long term investors, as the company is objectively cheap if they can get back to their historical margin profile.
2. Can I easily explain what the company does?
Yes, $SWK has two divisions; Tools & Outdoor which make up ~85% of sales with the remainder coming from Industrial. Their most notable brands are; DeWalt, Black + Decker, Craftsman, and Stanley.
3. Does the cash flow statement line up with income statement?
No cashflows have not come close to lining up with reported earnings:
This is a massive red flag, although most can be explained by a ~$1.2B buildup of inventories since the beginning of the year. Even still the numbers don’t seem to add up, which is typically an indication of dishonest management.
$SWK are serial acquirers totaling over $3.4B in outside purchases over the last two years alone. In fairness they are also selling off part of their industrial business, but on net they are acquirers and by a wide margin. I couldn’t find much information on their most recent acquisitions, but here’s a look at their merger and restructuring charges over the last 5 years:
As a reminder these charges are typically one off, but seem to show up every year on $SWK’s income statement??? This leads me to believe that; 1. earnings have been overstated historically and 2. $SWK is comically bad at buying outside businesses. The only saving grace here is that $SWK named a new CEO in July, unfortunately Donald Allan Jr has served as CFO at $SWK since 2008.
4. Is the Balance Sheet Healthy?
Total Cash: $282.2M
Total Debt: $11.59B
Current Ratio: 0.85
$SWK does hold meaningful debt and paid $224M in interest expenses last year. However operating income covers interest payments by nearly 7X, even if you think earnings are overstated that leaves plenty of breathing room. Additionally $SWK should throw off solid free cash flow over the next couple quarters and management has made it a point to pay down debt near term. All in all not a great balance sheet, but not bad either.
5. How profitable is the business?
Gross Margins: 30.1%
Operating Margins: 9.2%
Net Margins: 5.9%
Pretty bad numbers here, but this is likely due to short term macro noise. Here’s a look at what the business has done historically:
Under normal circumstances the business is quite profitable, which reflects their strong brands. The mean reversion in profitability makes $SWK an intriguing idea. For example if EBIT margins were 11.5% TTM their current multiple would be ~13.8X EV/EBIT. That’s around the cheapest the stock has traded in the last decade. With that said management did state that profitability will be choppy for at least 3 more quarters. However I don’t think it’s unrealistic to assume low double digit operating margins by 2024.
6. What is the company’s growth potential?
10-yr Revenue CAGR: 5.2%
10-yr Operating Profit CAGR: 7.12%
9-yr FCF CAGR: 12.22%
I chose to look at 9-yr FCF to eliminate some the noise caused by inventories in 2021. Nevertheless the business is growing at essentially a market rate. On the other hand most of this growth has been inorganic, as $SWK spent north of $6.6B in the last decade on acquisitions. However a majority of their business is selling consumer products, so there should no doubt be some organic growth as long as people continue buying power tools.
7. Is management rewarding shareholders?
$SWK currently offers investors a 3.47% dividend and have a $4B share repurchase program implemented. In the last year they’ve bought back $2.3B in shares, but this money is coming from the $3.2B sale of their oil and gas business. Moreover management stated in their last earnings call that repurchases are unlikely to be done for at least another year.
Over the last 5 years $SWK has averaged ~$800M in FCF annually and $100M in SBC. That leaves $700M on net for shareholders or a 5% shareholder yield. Although this assumes no further M&A activity, which in my estimation is unlikely to happen.
8. How does the company stack up against their peers?
I couldn’t find a company that primarily sells everyday power tools, so for that reason I’m gonna skip this question.
9. What’s the counter argument?
The bear argument is that it will take far longer than a few quarters for earnings to normalize and profitability won’t ever get back to 2017 levels.
I’m inclined to buy into this thesis, as there are many moving parts at $SWK. They’re divesting from existing businesses and buying new ones, while restricting their organization and implementing cost cutting measures. All these moves sound great on an earnings call, but I have little faith that management will execute in the time table they gave. For these reasons I wouldn’t be surprised if $SWK is dead money for the next couple of years.
10. Is there something I think the market may be missing?
Candidly I don’t, given the valuation Mr. Market seems to think the business can get back on track in fairly short order. The company is by no means cheap and earnings are anticipated to contract. Honestly after going thru the work $SWK seems overvalued here.
Final Thoughts:
I walked into this write-up with an open mind and hoping to find an attractive risk adjusted opportunity. After examining the facts, this is a business I won’t no part of. Chiefly because management is throwing off serious sleazeball vibes. If I can’t trust the numbers in your financial statements, I damn sure can’t put any faith into your business turnaround plan. Of course there’s a chance I’m wrong, but if it walks like a duck, quacks like a duck, then it’s likely to destroy shareholder value.
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice