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Illinois Tool Works will continuing to acquire businesses even during the recession

by Ashley N. Johnson
Jan 29, 2009

The $15-billion industrial manufacturer Illinois Tool Works Inc. expects that the recession will impact its sales, but not its well-established strategy of acquiring smaller businesses. The company’s stock has fallen and is currently at the low end of its 52-week historical range.

Glenview-based ITW continually buys small companies and improves their revenues. In 2008 ITW acquired 50 businesses with a total of $1.6 billion in annual revenue.  It currently owns over 850 business units in 52 countries, and 50 percent of ITW’s revenues come from overseas.

Alison Donnelly, ITW’s director of investor relations said, “It is a challenging time for every company…. What we have in our favor is a strong balance sheet, strong cash flow and global footprint.”

The company’s capital structure emphasizes its strong cash flow. Its total-debt-to-capital ratio is 28.3 percent, within the guidelines of where the company wants to be. ITW’s primary uses of free cash flow are for dividends and share repurchases as well as acquisitions. ITW estimates it spent $1.3 billion to $1.4 billion in share repurchases last year, which analysts at William Blair & Co. L.L.C. say should increase annual earnings per diluted share by 9 cents to 11 cents.

In 2008 ITW's income from continuing operations, impacted by the recession, declined 4.5 percent from 2007. but operating revenues of $15.869 billion were 6.7 percent higher than in 2007. That gain was possible only because of acquisitions, for the company's base revenues declined 2.5 percent in 2008. Acquisitions contributed 6.6 percent  to the revenue increase.

The company’s challenges in the end-markets are driven by downtuns in the North American automotive and residential markets, Donnelly said. One area where the company is growing has been in food equipment, in which 55 businesses account for $2.1 billion in revenue.

The nearly century-old diversified manufacturer also has interests in industrial packing, power systems and electronics, transportation, construction products, polymers and fluids, and an array of other businesses.

Donnelly said that adherence to the company’s 80/20 principle is a key to its success.  According to the company’s Web site, “80 percent of a company's sales are derived from the 20 percent of its product offering being sold to key customers.”

The fact that ITW is a decentralized company, Donnelly said, helps it when markets decline. The subsidiaries control their own employment, and some have had to cut jobs in the recession, but ITW has not been affected on the corporate level by layoffs.

In August ITW increased its annual dividend rate 11 percent from $1.12 to $1.24. 

William Blair & Co. analysts in a research note acknowledged that there are tough times ahead for ITW, but backed Donnelly’s statement of the company's being financially equipped to handle the economic slowdown. “In our opinion, the large fragmented nature of its end markets provides significant opportunity for product line and geographic expansion, the primary source of long-term growth,” analysts said.

John Kearny, a Morningstar Inc. analyst, said ITW’s exposure to the troubled U.S. housing and auto markets will not be offset by the international markets, which also are slowing down.  The recession is spreading in Europe, which generates about 30 percent of ITW’s sales.

But the slowdown is not too much of a concern for the company, Kearny said. “They’re kind of built for this…their diversified strategy helps them ride out the waves of the business cycle,” Kearny added.

Although ITW’s stock price has fallen, Kearny said, “Everybody’s stock price is falling.” The company’s stock, $33.04 on January 23, is on the low end of its 52-week range of $28.50 to $55.59.

William Blair & Co. analysts stated, “At $33, the stock is trading 15 times our 2009 EPS estimate, representing a 50 percent premium to the S & P 500 P/E, whereas the stock has historically traded at a 2 percent premium.” Yet, they wrote, on an absolute basis the 2009 P/E is at the low end of the company’s historical range of 12 to 21 times earnings.

Kearny said this is a good time for the company to acquire more businesses because it can get the companies for a cheaper price and ITW has a strong cash flow.

“Years ago a lot of private equity firms would be chasing after one company, which would shut out players like ITW.” Now there is little competition, Kearny said.