Stanley's Path to Profit Improvement and Sustainable Dividend Coverage May Take Until Late 2023

Stanley Black & Decker's earnings fell off a cliff last year as supply chain challenges, inflation, and a cooling housing market pressured margins and stunted demand.

With the toolmaker starting the year with inventory levels over double the usual amounts, management has guided 2023 Adjusted EPS to range from $0.00 to $2.00, representing another sharp annual decline.

With earnings stuck in the proverbial mud, Stanley's payout ratio will spike to over 300% – a sharp contrast to historically conservative levels.

Despite this alarmingly high payout ratio, Stanley predicts that curbing production and focusing on reducing its timeless inventory will generate free cash flow of around $500 million to $1 billion, enough to cover the roughly $500 million dividend this year.

Analysts also expect the company's earnings to rebound to around $5.20 per share in 2024, which would return Stanley's earnings payout ratio to about 60%, with coverage improving thereafter. 

A swift profit recovery reduces the odds that management would make major changes to the firm's capital allocation policies and help Stanley's leverage return to healthier levels within a reasonable period of time.

That said, in recognition that Stanley continues to operate with a challenging macroeconomic backdrop and efforts to cover the dividend with free cash flow could fall short, we are downgrading the firm's Dividend Safety Score from Very Safe to Safe.

 

This downgrade reflects the tool manufacturer's ongoing challenges in the short term and is not a signal for investors to dump the stock that was down over 50% last year.

Much of the firm's bad news and sour outlook is already priced into the stock, resulting in a dividend yield of over 3.5% – a rate not seen since 2009 when the economy was reeling from the housing market crash.

 

With Stanley trading at an attractive valuation, investors who believe in the company's long-term outlook and commitment to the dividend may find now an interesting time to consider the stock.

Stanley has paid uninterrupted dividends for 146 years and has a growth streak of 55 years, an impressive track record the firm would like to keep going.

That said, the A rated Stanley is operating with little wiggle room and needs to improve profitability while balancing dividend coverage and ongoing deleveraging efforts. 

Progress in reducing inventory in the back half of last year and cost-cutting measures underway provide some optimism for a rebound.

Even so, management doesn't expect earnings to notably improve until the back half of this year, requiring investors to be patient for a little longer.

Because a lot can change, for better or worse, in this dynamic environment, we will be keeping a close eye on Stanley.

If we don't see an improvement in dividend coverage and debt reduction towards the back half of this year, or if the recovery can keeps getting kicked down the road – we would consider another downgrade to Stanley's Dividend Safety Score.

As we keep tabs on Stanley, we will provide updates on any material change to the firm's dividend profile.