Tuesday, October 9, 2007

A Financial Analysis of The Stanley Works

The Appliance & Tools industry is a relatively small group of companies which commands a lot of demand from other organizations. Large-cap leaders such as Black & Decker and Whirlpool produce common products not only for large corporations, but for the retail consumer as well. While both these companies are relatively well-known, there are some other smaller, mid-cap corporations, such as Pentair and Jarden which also do quite well relative to fundamental performance. One mid-cap equity in particular, The Stanley Works (SWK), not only engenders solid growth for shareholders, but controls an excellent business model which creates increasing margin growth and an undervalued stock.

Before looking at the relative oversold nature of The Stanley Works it is vital to understand what the company produces. According to Reuters, "is a worldwide producer of tools for professional, industrial and consumer use and security products." Separating the business into three segments, "Consumer Products, Industrial Tools and Security Solutions," Stanley diversifies its company to hedge against risk-adverse demand fluctuations in any one industry. Consumer Products include production for "planes, hammers, and demolition tools", as well as "wrenches, sockets, and metal tool boxes" sold to retailers and third-parties. Similarly distributed, the Industrial Tools segment, sells "plumbing, heating, air conditioning and roofing tools" such as "pipe wrenches, pliers, press fitting tools and tubing cutters" both to third-parties and directly to the consumer. The last segment, Security Solutions, provides, "automatic doors, door locking systems, commercial hardware and integrates security access control systems"a comparable but different approach to business when compared to the other two regions of production.

While there are some notable differences between each of the three areas, some investors may argue that the general business model is fairly consistent throughout each segment, and because there are current problems related to the housing and manufacturing sector, it may not be a suitable time to invest in companies like The Stanley Works. However, there are two important reasons to not get discouraged by this observation. First, if technical analysis is correct, steel prices (a big commodity for Stanley) should come down in the next few months. Since January of 2005, when metallics on the CRU Steel Price Index were at 150, prices have escalated to a current reading of near 220. However, during this entire duration, the trend almost perfectly resembled an Elliot Wave to the upside. Now as the wave is near the peak, the correction should begin with an ABC pattern back to a familiar Fibonacci support level. If this does happen, lower steel prices would mean lower commodity prices for Stanley to paycontributing to higher operating and gross margins. In addition, to answer the question about a weak housing and manufacturing sector, Stanley, share price wise, has performed quite nicely. Even though much of this company's business is found with the slumping areas of the economy, in 2007 Stanley's share price has appreciated nearly 26%a number almost doubled of the S&P 500. In addition, Stanley has not had a negative calendar-year performance since 2002, and has only declined twice year-to-year in the past ten years. If Stanley can perform this well under such adverse conditions, there is absolutely some great potential for further share price growth.

Now while these models are great to examine and make speculations about, it is also important to understand how Stanley has performed and will perform relative to financial figures. Looking at the top-line over the past twelve months for this company and investors will see a $4.01 billion dollar number. Compared to the other top 15 market-cap leaders of this industry, Stanley places third in year-to-year growth. What is surprising, however, is how such a high sales figure still gives way for strong margin growth. According to Reuters, during the past twelve months, Stanley saw gross margins at 37.01% and operating margins at 9.93%. Comparing these numbers to five year respective averages of 35.56% and 9.29%, and an investor will realize that margin growth, despite high revenue, continues to grow. What makes these numbers even more intriguing is that the industry not only has smaller trailing respective figures at 28.86% and 7.69%, but each of these numbers are below the five year margin average as well. Even more specific to market-cap competitors, Black & Decker, albeit it has higher revenue than Stanley, has seen gross margins at 34.77% from its five year average of 35.69%. Another industry competitor, Jarden, is a similar story with a respective drop in gross margins from 26.74% to 24.72% and a drop in operating margins from 8.08% to 7.54%both coming at a revenue collection 5% lower than Stanley's trailing figure. Therefore, not only does Stanley have growing margins when the industry has decreasing gaps, Stanley is doing so with the third highest revenue production in the industry.

Furthermore, grow is also illustrated over the past year relative to sales and EPS numbers as well. Sales has grown at 18.92% from last year compared to the industry's respective growth of 14.51%, and EPS trailing growth at 33.71% is also quite high when looking at the industry's EPS difference of only 9.91%, according to Reuters. None of the market-cap industry competitors of Black & Decker, Jarden or Pentair can compete with these figures, despite lower revenue numbers, and only Jarden has a higher EPS difference than a year ago when compared to Stanley. What also separates Stanley from the other three companies is capital spending. Although a bit smaller than the industry average, Stanley still has a capital spending rate of 1.95%. This number is positive which not is the case for Pentair or Black & Decker. This is also illustrated with cash flow that is above free cash flow. Spending on CAPX now will allow for larger EBITDA figures latermore cash for buybacks or other incentives to lure investors. Overall, Stanley has put itself in a great position growth-wise and should continue to excel in both the short and long term with these figures.

What really separates Stanley, however, is its fundamentals when used against its share price. The forward P/E ratio of 15.95 for 2007, while not significant, is still lower than the industry trailing average of 19.00. In addition, this number is also quite similar to competitor Jarden and is below Pentair's 19.65 multiple. More specific to sales, Stanley has a reasonable price to sales figure of 1.24 which is in very close range of all three aforementioned industrial competitors. Forward enterprise value to revenue at 1.52 is respectable and continued cash growth from less CAPX spending in the future should contribute to lower multiple valuations and other discounted comparisons as well. Combining growth to value with the PEG ratio at 1.40 for Stanley, the number is below both Black & Decker at 1.91 and Pentair at 1.71. This number illustrates that Stanley is not only growing well, but is undervalued relative to this growth.

Respective to other intangibles, Stanley Works has performed quite well in these areas. CEO John F. Lundgren and his 17,600 employees headquarter in New Britain, Connecticut has managed to take advantage of investments and equity. All of ROA (7.58%), ROI (10.90%), and ROE (22.11%) are above not only the company's five year average, but above industry figures as well. The company is solvent with a most recent quarter current ratio of 1.34 and long term and total debt is also under control when compared to equity. Inventory, asset, and receivable turnover are all quite high compared to other competitors as well. Overall, Stanley Works is very susceptible to strong growth both in the short and long term with the current fundamental analysis.

Therefore, business strategy and fundamental analysis illustrate that Stanley Works is a profitable company which can be a great investment for any portfolio. Relative to technical analysis, while the RSI at 60 and a parabolic SAR below current share price may not look to enticing for the short-term investor, as a long-term investment, Stanley Works has the strong historical fundamental background and brand recognition to continue to help investors report strong capital gains for portfolios.

Dennis Biray presents advice on all kinds of topics ranging from finance and investing to fitness to sports. For more information email him at dbiray@gmail.com, or to view other articles written by him visit http://www.biraynetworks.co.nr