Black & Decker (BDK) isn't expecting a very jolly holiday season this year. The manufacturer of power tools and other household accessories announced a product recall on Dec. 14 and also slashed its fourth-quarter profit forecast, citing worse than expected market conditions in North America.
The Towson (Md.) company said it will recall certain DeWALT XRP cordless drills produced during the past 18 months, which will result in a pretax charge of $25 million in the fourth quarter of this year. The charge includes estimated costs to repair products returned by customers, as well as the hit from sales returns from distribution channels, but doesn't account for anything potential recouped from a component supplier. No injuries related to these products have been reported, it said.
More disturbing to investors, however, may have been the company's lowering of its earnings outlook just eight weeks after boosting it on a miscalculation of consumer demand, based on depleted inventories in distributors' warehouses, said Nicholas Heymann, an equity analyst at Sterne, Agee & Leach in New York.
The size of the profit outlook reduction indicates that distribution channel fill orders didn't materialize after Thanksgiving and that a second re-order won't occur either due to weaker consumer spending on remodeling and significantly softer holiday sales of consumer durable goods, Sterne Agee said in a Dec. 14 research note. (Sterne Agee has provided investment banking services for Black & Decker within the past year and makes a market in its securities.)
Black & Decker now expects to earn $1.03 per share in the fourth quarter, 36% below the $1.55 to $1.65 range it projected in late October. The new estimate excludes the favorable effect of a tax settlement agreement with the U.S. government on outstanding income tax litigation. The settlement will result in expected cash payments of roughly $50 million during 2008 instead of the $180 million bill the company would have had if the IRS had won its case.
For the full year, Black & Decker now estimates a profit of $6.00 per share, down more than 8% from its $6.50 to $6.60 forecast two months ago.
Wall Street analysts had a consensus estimate of $1.60 for the fourth quarter and $6.55 for all of 2007. Black & Decker shares were trading 5.7% lower at $75.59 on Friday.
So far, the company is keeping silent about the causes of the weaker-than-expected conditions in North America. But Heymann at Sterne Agee, who has a hold rating on the shares, points to a drop-off in demand in the remodeling market, which historically has served as an offset to weakness in new home construction.
Black & Decker had been prepared for a 25% downturn in revenue for 2007 and 2008 based on the slump in new home construction, Heymann said. But typically, whenever people don't move, they put money into fixing up the homes they have.
The remodeling market "seems to be getting crimped," to the degree that "the built-in stabilizer for suppliers to the housing industry" appears to have become much less an offset, he told BusinessWeek.com.
The reasons for homeowners' hesitation to invest in remodeling are unclear, but they probably don't include worries about wages, which are rising, or interest rates, which have been on the decline, he said. Instead, it may signal a change in how people are viewing their homes as places to store or create value, he added.
"There may be a rethinking by consumers, [asking themselves] 'Do I really want to put more money into my home? Am I going to get it back? Is it going to enhance the value of my home?'" he said.
Roughly 35% of the company's end markets are tied to the U.S. residential construction and remodeling markets, with an additional 18% closely linked to U.S. consumer spending, according to Sterne Agee's note.
Despite the deepening slump in the U.S. housing market, not all investors are getting nervous about holding Black & Decker in their portfolios, however. Chicago-based Ariel Capital Management, the second largest owner of the shares, has even added to its holdings since September, said Bob Goldsborough, vice president of research at Ariel.
"Our conviction in Black & Decker is as high as it's ever been," he said. "They have a terrific market position and continue to be really solid operators. There's no question that demand is going to come back."
Goldsborough also said the company has been quite adept at managing the business for a downturn and he expects it will continue to focus closely on reducing costs and buying back stock as a way to enhance shareholder value. Aiming to diversify and expand its overseas markets through a big acquisition wouldn't fit its management style, he said.
Ariel owned more than 4.3 million shares Black & Decker as of Dec. 11, Goldsborough said.
Standard & Poor's reaffirmed its hold rating on the stock but cut its 2007 earnings forecast to $6.60 and its estimate for 2008 to $6.35 per share, citing the likelihood that demand for many of its products will remain weak because of the housing slump. "With only one third of its sales outside the U.S., we believe Black & Decker may grow slower than [its] peers," S&P said in a Dec. 14 note, reducing its 12-month target price to $86 from $93. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)
In its research note, Sterne Agee said it no longer sees the stock trading between $80 and $90 per share and instead sees support in the low $70 range. If it can keep its 2008 profit above $6.00 per share, "that will indicate the company has managed through the likely toughest two years in OK shape," the note said. The stock price may have some upside from the company's robust stock buybacks, as it's been an aggressive repurchaser of shares in the past, Sterne Agee said. The board has authorized up to 4.9 million shares to be repurchased.