Wall Streeters must think it's tool time. Shares in The Stanley Works (SWK) climbed to a 52-week high of $53.42 on Apr. 11, after trading as much as 22% lower, at $41.41, less than a year earlier. Share prices soon leveled off from their peak, closing the following day at $52.52, down 1.7% from the Apr. 11 high. The New Britain (Conn.)-based company makes a variety of tools and security products, bringing in worldwide revenues of $3.3 billion in 2005.
Not too long ago, the stock looked like a fixer-upper. Stanley posted a 32% drop in fourth-quarter profit after the close of trading Jan. 25. Wall Street hammered the shares 7% in the next day's trading, to a dividend-adjusted $47.80. Ratings downgrades by Deutsche Bank and Standard & Poor's soon followed.
Now, the company's long-term prospects show greater leverage, analysts say. On Apr. 6, Deutsche research analyst Nigel Coe raised his rating on the stock back to buy from hold, citing increased confidence toward the company's projected earnings growth. "We believe the market is underpaying for this potential," Coe wrote. (Deutsche makes a market in Stanley.)
It helps that the toolmaker has done some remodeling. Stanley announced nearly $700 million of acquisitions in 2005, including deals for French tool maker Facom and Sterling (Ill.)-based National Hardware. Both buys provide potential cost savings, but investors may not have noticed, analysts say.
"Stanley's stock price seems to reflect almost no value accretion from the Facom and National acquisitions," Citigroup analyst Stephen Kim wrote in a Mar. 29 report maintaining a buy rating. (Citigroup has a significant financial interest and makes a market in Stanley.)
The question is how well Stanley can integrate its new additions. Management has set an annual earnings goal of $4.90 a share by 2008. Though that's up more than a third from the $3.18 earned last year, it's surprisingly realistic, according to Deutsche's Coe. The Facom business is "the biggest X-factor" for meeting that target, according to Coe.
Indeed, Stanley's European operations may need some restructuring to meet earnings assumptions. If so, Chairman and CEO John Lundgren's 11 years in European management roles could help the company dodge potential cultural pitfalls, Coe noted.
Other analysts aren't convinced. "We continue to be concerned regarding execution risk with its recent aggressive acquisition pace," J.P. Morgan analyst Michael Rehaut wrote in a Jan. 25 report reiterating a neutral rating. (J.P. Morgan provides liquidity in Stanley stock and has received investment-banking compensation from the company.)
Another possible source of improvement is Stanley's consumer-products business, which made up 34% of its 2005 sales. Big-box retailers have tightened the screws on inventory, contributing to the company's fourth-quarter profit shortfall. But after the first quarter, the likes of Home Depot (HD), Lowe's (LOW), or Wal-Mart (WMT) should be through with order reductions, analysts say (see BW, 06/06, "Renovating Home Depot"). Large retailers also provide much of Stanley's industrial product business, which accounted for 41% of sales last year,
Still, Stanley wasn't the only tool maker affected by lean retailer supplies. Rival Black & Decker (BDK) blamed "inventory patterns" in part for its own flat sales over the period. In fact, Black & Decker likely lost more first-quarter sales as a result of inventory changes than Stanley did, FTN Midwest analyst Eric Bosshard wrote in a Mar. 14 note maintaining a buy rating. (FTN Midwest makes a market in Stanley.)
As stores get back to stocking up, Stanley stands to gain market share in hand tools, according to Citigroup's Kim. A new line of high-end tools, FatMax Xtreme, targets professionals. The company is also entering the $200 million clamping category, where analysts like its chances against existing competitors Irwin (NWL) and Sears' (SHLD) Craftsman, made by Danaher (DHR). "We continue to be impressed with the improved pace and quality of new product introductions," Citigroup's Kim wrote.
Labor news may have contributed to the stock's Apr. 11 high. The same morning, the Hartford Courant reported Stanley was starting contract negotiations with union workers. The current contract reportedly covers 450 workers and expires May 13 -- in 2003, a strike shuttered two plants for 10 days. Company spokesman Gerry Gould declined to comment for this article. Everett Corey, directing business representative for Machinists Union District 26, didn't return calls prior to deadline.
Nevertheless, Stanley investors will be keeping a close eye on first-quarter earnings, scheduled for release Apr. 25. Analysts expect acquisition-related charges and restructuring charges involving severance programs to weigh on profits. Retailers' inventory drawdown should also continue to weigh on tool sales.
Meanwhile, tool demand is cyclical. Sales are linked to housing, construction, and remodeling trends, analysts say. After several strong years, those segments are expected to cool, which could cut into Stanley's revenues. "The real question will be if they're able to sustain similar levels of business as residential homebuilders work off some of their backlog," says Morningstar stock analyst Matthew Warren, who rates the stock two stars out of five.
Other question marks hang over Stanley's security division. The business, which includes automatic doors, mechanical and electronic locks, and related services, accounted for 25% of 2005 sales. Margins, while improving, remain inconsistent, analysts say. "People are going to be looking to see some more [improvement]," says Standard & Poor's senior industry analyst Amy Glynn, who also has a two-star (sell) rating on the stock.
Indeed, after Stanley's surprising surge, the Street will be watching carefully. If the company hits its marks -- and quiets the doubters -- the stock could ratchet even higher.