Stanley Black & Decker's earnings beat fails to satisfy Wall Street. Here's why we bought the dip

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Stanley Black & Decker overcame a soft demand environment to deliver a top and bottom line beat Thursday, but the stock is falling because the toolmaker simply reiterated its guidance. That's a fate shared by home-improvement peers and many other companies this earnings season. We added to our position on the pullback. Revenue fell 2% year over year in the January-to-March period to $3.87 billion, edging out the $3.82 billion expected by analysts, according to estimates compiled by LSEG. Adjusted earnings per share came in at 56 cents, topping the 54-cent estimate, LSEG data showed. Stanley Black & Decker Why we own it: Stanley Black & Decker is in the later innings of a multi-year restructuring plan. The company launched a series of initiatives designed to generate cost savings, optimize inventory, streamline and simplify the organization, and transform its supply chain. Although repair and remodeling demand environment is soft due to higher interest rates, management's cost-cutting plan will create a stronger company for the next cycle. As we wait for the turnaround to play out, we're getting paid a hefty dividend. Competitors: Bosch, Techtronic Industries and Illinois Tool Works Most recent buy: May 2, 2024 Initiation: June 14, 2023 Bottom Line Stanley Black & Decker turned in another solid quarter of execution on matters within management's control. It's making good on its plan of optimizing expensive inventory, reducing complexities and improving its supply chain to reach $2 billion in annual cost savings by the end of 2025. The progress is evident in the results, with adjusted gross margins continuing to improve. The one problem is the broader demand environment is still mostly soft, preventing management from raising the midpoint of its outlook. Given the stock's lackluster year-to-date performance, we would have thought investor expectations had come down enough to be satisfied with a beat and backing of guidance. However, there's always someone with their expectations too high. That's pushing the stock down more than 7%. Stanley Black & Decker's professional customers remain resilient, but demand from do-it-yourself customers has not returned to growth. This should be largely understood, and we expect to hear similar rhetoric when Home Depot and Lowe's report their earnings later this month. We probably won't see DIY activity meaningfully rebound until mortgage rates come down and reinvigorate the existing home sales market. We focus on existing home sales because the first thing people typically do after buying an older home is spend money on repair and remodeling projects. This dynamic makes Stanley Black & Decker one of the more interest-rate-sensitive stocks we have in the portfolio. We don't want to have too many of them in this "higher for longer" environment, but at least with Stanley Black & Decker our patience is being rewarded with hefty dividend yield of about 3.80%. The thesis may be taking longer to play out, but what management is doing to take out costs in the soft environment will make its earnings power look more impressive once the cycle turns. We are lowering our price target to $105 from $110 because rate cut expectations keep getting pushed out, extending the timing of the DIY market recovery. But we are reiterating our 1 rating and bought this pullback earlier Thursday. Quarterly commentary Stanley Black & Decker's largest segment by far — known as Tools & Outdoor — generated sales of $3.29 billion in the quarter, topping the $3.27 billion expected by analysts, according to FactSet. However, operating income of $279 million slightly missed analyst projections of $286 million, per FactSet. Volume growth of 1% in the company's flagship DeWalt power tools could not overcome a muted consumer and a soft do-it-yourself environment, which pressured sales for hand tools. Outdoor organic revenue was up 2% in the quarter, mostly driven by demand for handheld cordless outdoor power equipment. Pricing was flat, which we think is a positive because it shows the company isn't cutting prices to spur demand. Once you give up price in this business, it's very hard to get it back. Sales in Stanley Black & Decker's smaller Industrial segment— largely made up of fasteners in end markets such as automotive and aerospace — totaled $585 million in the period, missing the $596 million estimate, according to FactSet. Quarterly operating income in the segment of $71 million topped estimates at $63 million, according to FactSet. Organic sales fell 4%, partially offset by a 1% price increase across the segment. Within the segment, its so-called Engineered Fastening business saw organic revenues grow 5% thanks to a 30% increase in aerospace and a 4% increase in automotive. As a reminder, Stanley completed the divestiture of its Infrastructure business on April 1 for $760 million in cash. Net proceeds from the sale were used to reduce short-term debt in the second quarter. The company's adjusted gross margin performance of 29.0% was a solid mark, improving 590 basis points compared with last year and exceeding expectations of 28.7%. The result keeps the business on track to achieve its goal of about 30% over the full year. The gross margin improvements were driven by lower inventory destocking costs, supply chain transformation benefits and reduced shipping costs. Free cash flow was negative, which is typical with first-quarter seasonality. However, the result was a little better than expected due to inventory control. The company's capital deployment priorities this year are to invest in organic growth, fund the dividend, and strengthen the balance sheet. Stanley Black & Decker has been paying a dividend for 147 consecutive years, with increases in each of the past 56. Guidance Management made no real changes to its 2024 guidance. It still expects total company organic sales to be relatively unchanged, plus or minus low single digits. At the segment level, organic sales in Tools & Outdoor are projected to be relatively flat at the midpoint, while Industrial is expected to be relatively flat to slightly positive. Margins at Tools & Outdoors are expected to improve year over year, while Industrial is expected to remain flat. Management continues to expect adjusted EPS to be between $3.50 to $4.50. Considering the stock sell-off, Wall Street must have been looking for some signaling that earnings were trending toward the higher end of the range based on the consensus forecast of $4.14. This was way too optimistic. This modeling came well before the market erased its expectations for multiple interest rate cuts this year. While Stanley's wide earnings range leaves us ambiguity into the rest of the year, CFO Patrick Hallinan said he believes the midpoint of the range can be achieved due to costs controls. Meanwhile, management reiterated its full-year adjusted free cash flow of $600 million and $800 million. In addition, the company expects gross margins to increase sequentially in both halves of 2024 and total 30% for the full year. Gross margins are expected to be in the low 30s exiting the year, setting up 2025 for another year of strong year-over-year earnings expansion even if the demand environment stays tepid. The company's long-term adjusted gross margin target of 35% is supported by the $2 billion in annual cost savings it expects by the end of next year. "We remain confident that our transformation can support the sustainable cost structure and efficiency needed to return our adjusted gross margin to 35% or greater while enabling targeted growth investments," Hallinan said. (Jim Cramer's Charitable Trust is long SWK. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED. Stanley Black & Decker power drills are displayed for sale at a Home Depot store in Colma, California. David Paul Morris | Bloomberg | Getty Images