Long-Term Strategy Will Deliver 12-14% Total Annual Returns Driven by Revenue Growth, Margin Expansion and Buybacks
15.5% dividend increase backed by strong history of dividend payment, dividend growth and share buybacks
42% diluted EPS growth through organic growth, acquisitions, divestitures and margin expansion
Excellent revenue diversification by sector, customer and geography, “A” credit rating
Illinois Tool Works (NYSE: ITW) is a global manufacturer of specialized industrial equipment with operations in 56 countries and over $14 billion in annual revenue. The company has multiple business segments that serve a diverse customer base of industrial manufacturers with an 80/20 approach where each segment focuses on the 20% of its key customers that generate 80% of its revenues. This 80/20 strategy has led the company to industry leading operating margins, significant free operating cash flow and high returns on invested capital. Over the long-run, beyond 2017, ITW expects to deliver total annualized returns of 12% – 14%.
ITW has a portfolio of approximately 10,000 active patents which reflect management’s commitment to developing new and innovative products to meet growing customer needs.
2.1% Dividend Yield, 15.5% Dividend Growth
On October 31, 2014, Illinois Tool Works declared a regular quarterly cash dividend of $0.485 per share ($1.94 per share, annualized), payable January 6, 2015, to shareholders on record December 31, 2014, with a payout ratio of 25% and a dividend yield of 2.1%, slightly below its 5-year average dividend yield of 2.50% due to the sharp appreciation in share price. This dividend is the same as the prior quarter dividend, and is up 15.5% from the year-ago dividend.
ITW commenced dividend payments in September 2000, and has steadily paid and raised dividends over time.
ITW Shares Have Handily Outperformed the S&P 500 Index
Since January 1978, over the past 36 years, ITW shares have gained 14,204% in value, handily outpacing the 2,005% gain on the S&P 500 index. Over the past 1 years, ITW has delivered a total annualized rate of return of 9.6% including dividends, versus 4.1% for the S&P 500 index. And Fastgraphs predicts shares could rise to $121 per share over the next five years (by December 2019), with 7.4% annualized returns.
Illinois Tool Works’ shares closed at $93.91 (on 12/12/2014), up 18.2% year-over-year, well above the 10.9% gain for the S&P 500 index, giving the company a market capitalization of $36.48 billion with shares neat the high end of their 52-week range of $76.25 – $97.79 and above the company’s 50-day moving average ($93.33) and 200-day moving average ($88.04).
ITW shares trade at 21.1x earnings (above their historical average PE of about 18) and at 14.3x cash flow.
The company has strong margins, excellent cash flow and an “A” credit rating from Morningstar for its strong balance sheet and low default risk based on strong debt coverage ratios such as 13.25 EBITDA/Interest.
Excellent Revenue Diversification from Industrial, Commercial and Residential Customers
Illinois Tool Works operates seven business segments (see table below), each focused on a particular customer base. Each segment contributes between 12% and 17% of revenue, with excellent revenue diversification by product line, customer base and geography, and between 12% and 18.4% of operating income for excellent income and cash flow diversification.
The Automotive OEM segment makes components and fasteners for automotive-related applications through 5 brands and generates 17.1% of total company revenue. The Test & Measurement and Electronics segment makes equipment and software to test and measure materials and structures, and equipment for the production of electronic subassemblies and microelectronics through 13 brands and generates 15.8% of total revenue. The Food Equipment segment makes commercial food equipment and offers related services through 11 brands and generates 15.5% of total revenue. The Polymers & Fluids segment makes products for automotive, janitorial and hygiene needs through 17 brands and generates 13.2% of total revenue. The Welding segment makes welding equipment and accessories through 8 brands and generates 12.4% of total revenue. The Construction Products segment makes fastening systems and truss products through 10 brands and generates 12% of total revenue. Lastly, the Specialty Products segment makes equipment and consumables for diverse needs through 8 brands and generates 13.9% of total revenue.
On May 1, 2014, Illinois Tool Works completed the divesture of its industrial packaging business to private equity firm Carlyle Group for $3.2 billion – to generate cash flow for growth and acquisitions and to focus on growth-oriented businesses.
$6 Billion Buyback Program Boosts Shareholder Value
ITW initiated a $6 billion share buyback plan in 2013, to repurchase 50 million outstanding shares. As of September 2014, the company had repurchased approximately 41.5 million shares and had $2.3 billion still available for additional buybacks under the 2013 program.
Enterprise Strategy Focused on Growth, Returns and Operational Excellence
ITW operated under an Enterprise Strategy that focuses on key initiatives to deliver targeted results.
Its business model has three legs – the 80/20 process, innovation and decentralization. And its operational initiatives include active portfolio management, simplified operations and strategic sourcing. For example, since 2011, ITW has completed 30 strategic divestures to support growth and finance acquisitions, and merged 800 divisions down to 89 divisions under its business structure simplification strategy. Management plans to continue this strategy to further streamline operations in 2015 and squeeze 1% in annual savings through strategic sourcing.
Overall, the company plans to reap $600 million – $800 million in annual cost savings through 2017 and boost its operating margin by 7% to 23%.
Management Increases Earnings Guidance with 14% EPS Growth
In December 2014, management updated earnings guidance for Q4, FY2014 and FY2015. For Q4, they expect earnings of $1.07 – $1.15 per share. For FY 2014, ITW expects earnings of $4.57 – $4.65 per share, up from earlier guidance of $4.50-$4.62 per share, with $14.5 billion in total revenue, 20% operating margin and 18% – 19% return on invested capital.
For FY2015 management forecasts earnings of $5.15 – $5.35 per share, up 14% over 2014, on revenue growth of 0.5% – 1.5% and operating margin expansion to 21%. In 2015, management plans to spend $1.5 billion on share buybacks and distribute $500 million in dividend payments.
Wall Street Raises Share Price Targets on Long-term Strategy, Guidance
The 22 analysts who cover ITW have an average Buy recommendation on ITW shares based on 12.6% long-term earnings growth that is well above industry peers, with 12-month share price targets averaging $101 and ranging from $86 – $111, for 6.3% one-year upside.
Limited Fallout from IRS Tax Litigation
In June 2014, Illinois Tool Works was charged with willfully avoiding about $357 million in cross-border taxes by the Internal Revenue Service (IRS). The IRS accused the company of using a loan from its Bermuda subsidiary to bring foreign cash into the U.S. as a tax-free transaction instead of classifying the transaction as a taxable repatriation of foreign profits. As a result, the company could face a fine of $70 million if it loses its case against the IRS. However, fallout from this litigation will likely be minimal and resolution should have a positive effect on shares.
Proven Management with Solid Long-Term Growth Strategy
E. Scott Santi was named President and Chief Executive Officer of Illinois Tool Works in November 2012. Santi originally joined the company in 1983 when he started his professional career, and has been a driving force behind the company’s long-term strategy, execution and success. Over the past year, Santi delivered handsome double-digit returns on equity and invested capital.
Michael Larsen has served as Senior VP and Chief Financial Officer of Illinois Tool Works since joining the company in 2013. Prior to his current position, Larsen held senior positions with Gardner Denver Inc. and General Electric (GE), and is well versed with the equipment supply business.
David Parry was named Vice Chairman in 2010 and has been with the company for 20 years. Parry brings over 17 years of international management experience to the company.
Across-The-Board Revenue Gains Drive Record Operating Income, 42% Diluted EPS Growth
For its third quarter ended September 30, 2014, Illinois Tool Works had operating revenues of $3.69 billion (up 3%), operating income of $772 million (up 14% and an all-time record high), income from continuing operations of $507 million (up 25%) and net income of $531 million (up 17%). Diluted earnings per share from continuing operations were $1.28 per share, up 42%, with a 1.9% improvement in operating margin and a 2.5% increase in return on invested capital.
Operating revenues were led by a 7% increase in Automotive OEM revenue, a 6% increase in Test & Measurement and Electronics revenue, a 6% increase in Food Equipment revenue, a 5% increase in Welding revenue, a 1% increase in Construction Products revenue and a 1% increase in Specialty Products revenue.
In addition, margins improved across all segments and were up 200 basis points in five segments, and drove record quarterly operating income.
As of September 30, 2014, Illinois Tool Works had $4.82 billion in cash and cash equivalents, $19.03 billion in total assets, $6.03 billion in long-term debt and $7.8 billion in total stockholders’ equity.
In the quarter, the company $678 million in adjusted free operating cash flow.
Illinois Tool Works offers excellent long-term total returns of 12-14% driven by improvements across the board – with revenue growth, margin expansion, divestitures, dividends and buybacks. Management is focused on all relevant vectors to boost long-term shareholder value. The company has strong fiscal discipline and an “A” credit rating, with a strong portfolio of granted and pending patents for IP-led leadership in the industrial equipment sector. In its recent quarter, the company reported record high operating income which reflects the effectiveness of management’s long-term strategy.