CONSERVATIVE GROWTH

Illinois Tool Works, Inc.

Ticker symbol: ITW (NYSE) Image Large Cap Image Value Line financial strength rating: A++ Image Current yield: 2.8% Image Dividend raises, past 10 years: 10

Company Profile

Illinois Tool Works is a multinational conglomerate involved in the manufacture of a diversified range of mostly industrial intermediary and end products. Customers include the automotive, machinery, construction, food and beverage, and general industrial markets. The company currently operates some 85 businesses in seven segments in 55 countries, employing approximately 48,000 people. Some of the products are branded and familiar, like Wolf and Hobart kitchen equipment and Paslode air power tools; most are obscure and only known to others in their industries. Sales outside North America account for 48 percent of the total.

The seven segments are presented here with approximate revenue percentages:

In 2012, the company embarked on a five-year “Enterprise Strategy” program aimed at simplifying the business and applying sound customer-driven operating principles to fine-tune its base of customers, markets, products, facilities, and supply chains. Emphasis is placed on removing customer pain points, reducing complexity by applying the “80–20” rule (focusing on the 20 percent of customers, products, and processes that deliver 80 percent of the results), customer-driven innovation, and fine-tuning the relationships between headquarters and the operating entities. Growing organically (instead of by acquisition) and improving margins are the chief business objectives; the main strategy is to focus on businesses with strong sustainable differentiation. The company closely monitors operating margin improvements in each of its seven segments. We normally don’t bring too many such strategic initiatives to light, but we will in this case because (1) it’s working, and (2) such focus is needed in a company with such size and operating complexity; otherwise, it quickly becomes an uncoordinated conglomerate jumble, as many others before it have. ITW has divested 30-plus businesses and two segments, simplified the rest from 800 business units to 85 businesses (“divisions”), achieved a 1.1 percentage-point gain in operating margins in 2018 alone, and identified specific growth drivers in each of the seven segments.

These efficiency measures and “80–20” thinking have not only improved profitability of continuing operations but have also guided the company’s thinking in terms of acquiring and selling businesses and in strategically managing the fundamentals within those businesses. The net result can be no better demonstrated than by the fact that in the five years since 2012, per-share earnings have increased 109 percent while revenues have decreased 18 percent in that time. In our view, good management has had no finer hour, and we continue to appreciate ITW’s efforts and look forward to the ongoing benefits of this initiative into 2020.

Financial Highlights, Fiscal Year 2018

FY2018 was another year of solid profit gains exceeding revenue gains, fueled both by strong end markets and customer relationships and internal improvements built on the Enterprise strategy. FY2018 net sales advanced 3.2 percent as some slowness crept into the Automotive, Construction, and Specialty Products businesses, while net earnings managed a 9.3 percent increase. Projections call for a 3–5 percent earnings gain on relatively flat sales in 2019, followed by a 4–6 percent earnings gain on a 2–4 percent sales gain in 2020, as many of the end markets level off a bit. The company commits half its profits each year to shareholder returns through dividends and buybacks and plans to increase its payout ratio (dividends to free cash flow) from 43 to 50 percent in the coming years, which will probably bump the dividend as much as 25 percent over that time. ITW bought back about 2.5 percent of its shares in 2018.

Reasons to Buy

Buying shares of ITW continues to be like buying a fund of medium-sized manufacturing businesses you’ve probably never heard of but would definitely like to own. Indeed, think of it as the Berkshire Hathaway of manufacturing companies if you will—we do. We much admire this management team, with its solid strategic focus and drive to benefit shareholders. Headquarters prescribes the strategies such as margin focus and the 80–20 mindset; managers of the subsidiary businesses have the autonomy to figure out how to deliver results. The model works. We enjoy doing this presentation every year; it’s a good tour through how to run a modern conglomerate effectively in an era where many have stumbled, and the company presents itself well to investors.

ITW is well diversified and serves many markets, some with end products, some with components, some in cyclical industries such as automotive and construction, some in steady-state industries like food processing. The businesses balance each other out. The company has solid models for making acquisitions and seems to do better than most conglomerates historically in choosing candidates and then managing them once they’re in the fold. The “Enterprise” initiative is turning opportunity into cash flow and using that cash flow to enhance shareholder returns.

Reasons for Caution

ITW is, by its nature, tied to some of the more volatile elements of the business cycle, so it may not be the best pick for investors living in fear of the next downturn. In particular, we worry a bit about the Automotive segment going forward, although recently the unit has been gaining share in the automotive market. Indeed, it does seem that things are leveling off a bit, but the 80–20 focus and attention to profits should keep them headed in the right direction through this period. Conglomerates are notoriously difficult to manage (it’s hard enough to manage one business, let alone 85 of them); that said, the company has made a conscious decision to downshift its acquisitions for now.

SECTOR: Industrials Image Beta coefficient: 1.10 Image 10-year compound earnings per-share growth: 7.0% Image 10-year compound dividends per-share growth: 12.5%

 

2011

2012

2013

2014

2015

2016

2017

2018

Revenues (mil)

17,787

17,924

14,135

14,484

13,405

13,599

14,314

14,768

Net income (mil)

1,852

1,921

1,629

1,890

1,886

2,036

2,302

2,563

Earnings per share

3.74

4.06

3.63

4.67

5.13

5.70

6.78

7.60

Dividends per share

1.38

1.46

1.60

1.75

2.07

2.40

2.73

3.56

Cash flow per share

5.06

5.55

5.20

6.25

7.17

7.22

8.09

9.21

Price:

high

59.3

63.3

84.3

97.8

100.1

128.0

169.7

179.1

 

low

39.1

47.4

59.7

76.3

78.8

79.1

120.1

117.8

Website: www.itwinc.com