Venerable American conglomerate ITT Inc. (ITT, Financial) came into being 100 years ago as International Telephone & Telegraph, bringing three networks in the Caribbean under one umbrella. After a couple of name changes, it became known as its current name in 2016.
During the 1960s and 1970s, under the leadership of Harold Geneen, it used leveraged buyouts to grow rapidly in all directions at once. During his 18-year tenure as CEO, the company did some 350 acquisitions or mergers.
As the 20th century moved along, investors began losing interest in conglomerates, looking instead for purer plays that focused on individual businesses. In response, ITT began dismantling itself. It now has three focused segments, according to its 10-K for 2019:
- Motion Technologies manufactures products such as brake pads and shock absorbers for the transportation industry. It makes products for passenger cars, trucks, military vehicles, train cars and other vehicles.
- Industrial Process specializes in industrial pumps and valves, as well as plant optimization and services. Its customers include companies in the oil and gas, chemicals, mining, pulp and paper, food/beverages and power generation industries.
- Connect & Control Technologies focuses on electrical connectors, electrical controllers and cable assemblies. Its customers include aerospace, defense, transportation and oil and gas companies.
All segments have one shared interest: "Our businesses share a common, repeatable operating model centered on our engineering capabilities. Each business applies its technology and engineering expertise to solve our customers' most pressing challenges."
But, they also shared something else this year—reversals due to Covid-19 and the associated economic downturn. Segments that serve the auto industry, oil and gas and aerospace were all pulled down in the first and second quarters.
When ITT released its Q2 2020 results at the end of July, there was bad news in several areas of the earnings report. On an unadjusted basis:
- Revenue was down 29%.
- Operating income margin declined by 770 basis points (350 basis points after adjustments).
- Earnings per share were down 29%.
Not all the news from the second quarter was bad; free cash flow increased by 205%, it had $819 million in cash on hand and $1.4 billion in available liquidity. The company considered itself well-positioned to ride out the current storms, and a look at the fundamentals backs up that opinion.
Financial strength
The first five lines of the financial strength table reflect ITT's debt, equity and assets. Value investors will be relieved to see it currently carries a relatively low debt load. This GuruFocus chart puts the debt into context:
Early in the past decade, management did a good job of bringing down the debt, and bringing it down quickly. Both the Piotroski F-Score and the Altman Z-Score are solid. The spread between the return on invested capital (ROIC) and the weighted average cost of capital (WACC) is narrow but positive.
However, a closer look at ROIC shows we should be less confident; here's a chart covering the metric over the past 10 years:
Profitability
Why, you might ask, does ITT receive only a 7 out of 10 score for profitability when there is so much green on the table?
Double-digit margins aren't enough by themselves; the operating margin is simply the first of the factors that contribute to the overall rating. Here's the list of factors considered by GuruFocus:
- Operating Margin %
- Piotroski F-Score
- Trend of the Operating Margin % (five-year average)
- Consistency of the profitability
- Business Predictability Rank
The operating margin, as we saw, is quite favorable, but next is the Piotroski F-Score, which is just 6 out of 9. Also, the trend of the operating margin is relatively flat:
Consistency of the profitability depends to a certain extent on which measure we choose. However, as we saw in the ROIC chart above, the results have bounced around over the past decade. GuruFocus gives ITT a business predictability rank of just 1 out of 5 stars, which is at the bottom of the scale.
While it's not part of the profitability ranking, revenue growth is an issue, according to a GuruFocus warning sign. That would reflect just the two most recent quarters, however. Between the beginning of 2017 and the end of 2019, the company did well, as shown on this five-year chart:
Also, observe in the table how the company is becoming more efficient in its operations, as Ebitda and earnings per share grow more quickly than revenue.
Valuation
According to the GuruFocus Value chart, ITT is "modestly overvalued." However, the price will soon pierce the next band if it keeps increasing, which would put it into significantly overvalued territory.
The price-earnings ratio currently stands at 17.86, which is below the Industrial Products industry median of 24.02 and slightly above its own 10-year median of 15.95.
The PEG ratio shows overvaluation at 3.02. When the price-earnings ratio is in the mid-teens, the PEG ratio shows overvaluation, so we might expect that Ebitda growth has been quite low; the PEG ratio is calculated by dividing the the price-earnings ratio by the five-year Ebitda growth rate.
However, average growth rates can be deceiving, as we see in this five-year chart of the Ebitda year-over-year growth rate. Is ITT in a long-term decline with a couple of up years, or did it regain some of its Ebitda power in 2019?
Given the pandemic situation, we might expect Ebitda to turn down again this year. From a broader perspective, I believe ITT is pushing the upper limits of "modestly overvalued" and is in danger of becoming "significantly overvalued."
Dividends
Dividends come out of free cash flow, the funds remaining after all the bills are paid and cash flow is up. As we noted above, the dividend payout ratio was up 205% from the second quarter of 2019.
Still, the dividend is low and at most might partially offset inflation. That's helpful, of course, but at 1.01% it certainly will not make anyone rich. Since the share buyback ratio is also low, investors will have to be satisfied with capital gains alone.
There is room to grow the dividend since the dividend payout ratio is just 18%. However, it will not grow much based on what we've seen over the past three years; the dividend growth rate has averaged just 5.8% per year. When a dividend is as low as ITT's, it will take a much higher growth rate to get it to the point where it will interest income investors.
The forward dividend yield is slightly higher than the trailing twelve-month yield, reflecting a quarterly increase from $0.147 to $0.169 in March.
The five-year yield-on-cost is also low, just 1.31%, because we are combining a low starting point with a low rate of dividend growth. The share buyback ratio is low, meaning earnings per share haven't improved that way. Based on this 10-year chart, the number of shares declined just 6% since 2013:
Gurus
Among the investing giants followed by GuruFocus, many were buyers when the share price took a dive earlier this year, but their enthusiasm didn't last:
Six gurus were owners of ITT at the end of the second quarter, but none of them held a significant numbers of shares. Mario Gabelli (Trades, Portfolio) of GAMCO Investors had the biggest stake with 392,531 shares after reducing his holding by 21.23%. His position represented a 0.45% piece of ITT.
Pioneer Investments (Trades, Portfolio) added 14% in the quarter ended June 30 to finish with 112,460 shares.
Jim Simons (Trades, Portfolio) of Renaissance Technologies nearly doubled his previous holding to finish the quarter with 90,500 shares.
Conclusion
The gurus may have relatively modest holdings in ITT Inc., but other investors apparently have more confidence in the company. Why else would the shares be overvalued to such an extent?
There are numerous positive metrics that investors would like, but at the same time there are negatives that must be recognized. Management has done a good job of bringing down the debt load, but year-to-year financial outcomes are inconsistent, as shown by the low predictability rating. There is certainly promise in this name, but it hasn't yet become a mature and reliable generator of returns.
Growth investors could put ITT on their shortlists because it has generated strong capital gains over the past decade. Value investors will find the stock price too expensive and a long way from providing a margin of safety.
I do not own shares in any of the companies named in this article.
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