Illinois Tool Works Inc. (ITW, Financial) was founded in 1912 and incorporated in 1915. It is a Fortune 150 global diversified industrial manufacturer of value-added consumables and specialty equipment with related service businesses. ITW focuses on profitable growth and strong returns across worldwide platforms and businesses. The businesses serve local customers and markets around the globe, with a significant presence in developed as well as emerging markets. ITW's revenue totaled $17.8 billion in 2011, with more than half of the revenue generated outside of the United States.
Valuation
ITW is currently trading at a trailing twelve months P/E of 14.6, a 4.5% discount to its five year average P/E of 15.3. It is also valued at a trailing twelve months EV/EBITDA of 8.8x. ITW has delivered a five year average ROE of 17.7% and 10 year book value per share CAGR of 7.6%.
Financial And Business Risks
ITW is moderately geared with a gross debt-to-equity ratio of 48.7% and a net gearing of 28.7%. This is partly mitigated by an interest coverage ratio of 14.2 and a debt-to-EBITDA ratio of 1.4. ITW has approximately $5 billion of debt on its book; this does not take into account operating lease payments of about $400 million for the next five years.
The markets in which ITW operates in, are largely fragmented, and ITW encounters a variety of competitors including regional or specialized companies, as well as large U.S. and non-U.S. companies or divisions of large companies. Each of its segments generally has several main competitors and numerous smaller ones in most of their end markets and geographic areas.
ITW uses raw materials of various types, primarily steel, resins, chemicals and paper, that are available from numerous commercial sources. ITW has not experienced any problems with availability of materials in the past, and does not anticipate any such problems going forward.
Business Quality and Capital Allocation
For the past 25 years, ITW has achieved a revenue CAGR of 12%, a net income CAGR of 13% and an average ROIC of 14%. ITW has positive operating cash flow and free cash flow for the past ten years, with 2001 to 2011 operating cash flow representing 116% of net income. ITW's operating margins have consistently been above peers, with a five year average operating margin of 14.2%. In contrast, the peer group, defined by S&P Capital IQ, delivered a five year average operating margin of 10.7%. Operating margin is calculated as earnings before taxes plus net interest expense and total other non-operating expenses, divided by total revenue.
ITW believes that its primary competitive advantages derive from its decentralized operating structure, which creates a strong focus on end markets and customers at the local level, enabling its businesses to respond rapidly to market dynamics. In addition, its global footprint is a competitive advantage in many of its markets, especially in the transportation segment.
ITW has an active acquisitions and divestitures policy. For ITW, acquisitions must both fit with key segment and platform growth strategies and deliver returns at or above company average within three to five years. It also periodically reviews its operations for businesses which may no longer be aligned with its long-term objectives and considers them for divestiture. In August 2012, ITW entered into a definitive agreement to divest its 51% interest in the Decorative Surfaces segment for cash proceeds of approximately $1.05 billion. The transaction is expected to close in the fourth quarter of 2012.
ITW has paid out dividends in every single year since 1995 and has a dividend payout guideline of 30% to 45% of the average of the last two years’ free operating cash flow. It currently has a dividend yield of 2.5% with a dividend payout ratio of 35.3%. Dividends are paid out quarterly.
From 2007 to 2011, 37% and 26% of free cash flow were returned to shareholders in the form of net share repurchases and dividends respectively. In 2011, ITW generated $1.6 billion of free operating cash flow and returned an equal amount of $1.6 billion to shareholders via dividends and share repurchases. Year-to-date, ITW has spent $1.4 billion and $515 million on share repurchases and dividends respectively. Share repurchases have reduced the share base substantially by 15% since 2007 - shares outstanding have dropped from 551 million shares to current shares outstanding of 464 million shares.
Conclusion
A risky acquisiton driven growth strategy is offset by ITW's long track record of free cash flow generation, dividends and share repurchases. Valuations are fair.
Disclosure
The author does not have a position in any of the stocks mentioned.
Valuation
ITW is currently trading at a trailing twelve months P/E of 14.6, a 4.5% discount to its five year average P/E of 15.3. It is also valued at a trailing twelve months EV/EBITDA of 8.8x. ITW has delivered a five year average ROE of 17.7% and 10 year book value per share CAGR of 7.6%.
Financial And Business Risks
ITW is moderately geared with a gross debt-to-equity ratio of 48.7% and a net gearing of 28.7%. This is partly mitigated by an interest coverage ratio of 14.2 and a debt-to-EBITDA ratio of 1.4. ITW has approximately $5 billion of debt on its book; this does not take into account operating lease payments of about $400 million for the next five years.
The markets in which ITW operates in, are largely fragmented, and ITW encounters a variety of competitors including regional or specialized companies, as well as large U.S. and non-U.S. companies or divisions of large companies. Each of its segments generally has several main competitors and numerous smaller ones in most of their end markets and geographic areas.
ITW uses raw materials of various types, primarily steel, resins, chemicals and paper, that are available from numerous commercial sources. ITW has not experienced any problems with availability of materials in the past, and does not anticipate any such problems going forward.
Business Quality and Capital Allocation
For the past 25 years, ITW has achieved a revenue CAGR of 12%, a net income CAGR of 13% and an average ROIC of 14%. ITW has positive operating cash flow and free cash flow for the past ten years, with 2001 to 2011 operating cash flow representing 116% of net income. ITW's operating margins have consistently been above peers, with a five year average operating margin of 14.2%. In contrast, the peer group, defined by S&P Capital IQ, delivered a five year average operating margin of 10.7%. Operating margin is calculated as earnings before taxes plus net interest expense and total other non-operating expenses, divided by total revenue.
ITW believes that its primary competitive advantages derive from its decentralized operating structure, which creates a strong focus on end markets and customers at the local level, enabling its businesses to respond rapidly to market dynamics. In addition, its global footprint is a competitive advantage in many of its markets, especially in the transportation segment.
ITW has an active acquisitions and divestitures policy. For ITW, acquisitions must both fit with key segment and platform growth strategies and deliver returns at or above company average within three to five years. It also periodically reviews its operations for businesses which may no longer be aligned with its long-term objectives and considers them for divestiture. In August 2012, ITW entered into a definitive agreement to divest its 51% interest in the Decorative Surfaces segment for cash proceeds of approximately $1.05 billion. The transaction is expected to close in the fourth quarter of 2012.
ITW has paid out dividends in every single year since 1995 and has a dividend payout guideline of 30% to 45% of the average of the last two years’ free operating cash flow. It currently has a dividend yield of 2.5% with a dividend payout ratio of 35.3%. Dividends are paid out quarterly.
From 2007 to 2011, 37% and 26% of free cash flow were returned to shareholders in the form of net share repurchases and dividends respectively. In 2011, ITW generated $1.6 billion of free operating cash flow and returned an equal amount of $1.6 billion to shareholders via dividends and share repurchases. Year-to-date, ITW has spent $1.4 billion and $515 million on share repurchases and dividends respectively. Share repurchases have reduced the share base substantially by 15% since 2007 - shares outstanding have dropped from 551 million shares to current shares outstanding of 464 million shares.
Conclusion
A risky acquisiton driven growth strategy is offset by ITW's long track record of free cash flow generation, dividends and share repurchases. Valuations are fair.
Disclosure
The author does not have a position in any of the stocks mentioned.
