By Meredith Wilson<\/p>\n
Analysts are confident that Glenview-based Illinois Tool Works Inc. will continue to post profits in the coming years, but are concerned with the long-term feasibility of the company\u2019s current growth plan, a reversal of its historic rapid-acquisition policy.<\/p>\n
Forty-eight percent of analysts rate ITW stock as \u201cbuy,\u201d and another 48 percent rate it as \u201chold.\u201d On March 4, the stock was valued at $98.20. Its 52-week high was $101.82 and its low was $79.06. Analysts set the 12-month target price at just $101.82, the recent high.<\/p>\n
The consensus earnings-per-share \u00a0estimate is for ITW to experience 11.86 percent growth in 2015 and 10.9 percent average annual growth over the next five years. The price-to-earnings ratio is projected to decrease to 18.81 in 2015 from 21.03 in 2014.<\/p>\n
ITW\u2019s growth potential is the result of its ability to successfully execute its five-year “enterprise strategy” begun in 2012. That strategy is centered around streamlining its holdings to focus on the highest-yielding products through portfolio management, business simplification and strategic sourcing.<\/p>\n
\u201cThe extent of margin improvement culminating from ITW’s three major five-year initiatives is the primary valuation\u2028driver,\u201d Morningstar Inc. analyst James Krapful said in his Feb. 19 research note.<\/p>\n
Since launching its enterprise strategy, ITW has sold its “most commodified” 25 percent of revenue and slashed the number of entities it holds from 800 to 90, resulting in healthier operating margins and a stronger revenue profile.<\/p>\n
\u201cWe see Illinois Tool Works as a fine operator of the 80\/20 business process, in which resources are dedicated to 20 percent of customers, products, and processes that drive 80 percent of revenue and profit,\u201d Krapful said.<\/p>\n
ITW is a diversified global manufacturer of industrial products and equipment. Diversification, its position as a brand leader in several markets, as well as the company\u2019s \u201centrenched position with most of its customers,\u201d insulate the company from being overtaken by competitors, according to Krapful.<\/p>\n
It also helps insulate the company from economic upheaval.<\/p>\n
\u201cOverall, the diversified business mix helps to limit the impact of cycles in any single market, \u201c Matt Arnold, Edward D. Jones & Co. L.P. analyst, said.<\/p>\n
Several analysts see the strength of ITW\u2019s cash flow and an strategy of share buybacks and acquisitions as signals of good management.<\/p>\n
\u201cWe believe the firm does a responsible job in allocating its strong free cash flows and incremental debt proceeds. Investments that are intended to drive organic growth and margins take precedence,\u201d Krapful said.<\/p>\n
Illinois Tool Works reported $1.9 billion of adjusted free cash flow for 2014. The amount of adjusted free cash declined by 8.4 percent from 2013, when the company reported $2.2 billion in adjusted free cash flow. Long-term debt increased from $2.8 billion in 2013 to nearly $6 billion in 2014.<\/p>\n
While most analysts have faith in ITW\u2019s enterprise strategy to improve margins and better position itself in a global market, they are concerned about the company long-term.<\/p>\n
“We are a little worried about what the company will do to keep growth\/improvement going post 2017,\u201d BMO Capital Markets Corp. analyst Joel Tiss said in his most recent research note.<\/p>\n
ITW posted \u201csoft\u201d revenue growth in 2014 of 3.5 percent, and the company projects its 2015 total revenue to shrink by 2 percent, primarily due to foreign currency fluctuations, according to an ITW press release.<\/p>\n
Krapful notes that the company has averaged only 1.5 percent organic revenue growth over the past 12 years.<\/p>\n
\u201cThe firm’s subpar organic revenue growth prospects temper our enthusiasm somewhat,\u201d Krapful said. \u201cIt is too early to tell whether long-run returns will suffer as a result [of the enterprise strategy].\u201d<\/p>\n
Beyond dampening revenue projections, the enterprise strategy may blunt the company\u2019s competitive edge.<\/p>\n
\u201cThe company\u2019s business structure simplification initiative could dilute some of the benefits of its decentralized model, such as its ability to rapidly respond to market changes and foster strong customer relationships,\u201d Krapful said.<\/p>\n
Alison Donnelly, director of communications for ITW, declared that while streamlining the company\u2019s holdings will produce a drag on revenue in the short term, it will create a strong portfolio of businesses ready to grow in 2016 and beyond.<\/p>\n
\u201cIf you take a look at our auto business, it\u2019s further along in the process. In Q4, organic growth was 7 percent, compared to 1 percent in the market. It just shows that we are capable of growing these businesses,\u201d Donnelly said.<\/p>\n
Overall, Arnold, of Edward D. Jones, is not as concerned as other analysts about the potential negative effects of the company\u2019s simplification strategy. He gives ITW a \u201cbuy\u201d rating and s says it’s well-positioned for overall growth and investment returns.<\/p>\n
\u201cWe believe ITW is a well-managed, diversified industrial company that should benefit from a gradual economic recovery,” Arnold wrote. “It also has a strong track record of dividend growth and new product innovations that should bode well for shareholders in the future.\u201d<\/p>\n
Tiss, of BMO, while giving the company an \u201coutperform\u201d rating, is anxious to see a concrete strategy for revenue growth. He believes that the company\u2019s revenue strategy will \u201cmove back toward acquisitions more aggressively.\u201d<\/p>\n
Krapful believes the company needs to contend with the fact that its holdings are \u201cmostly mature with subpar growth prospects.\u201d The company has signaled that it plans to purchase fewer, higher-value companies every year rather than its historic strategy of buying 50 lower-cost companies every year.<\/p>\n
He sees some \u201cidiosyncratic risk\u201d in the company\u2019s signaled strategy, reasoning that It may be harder for ITW to spend 20 percent of its revenue for 80 percent of its profit when its acquisitions are more expensive; the company is at risk of overpaying for its acquisitions; management may not understand the unrelated companies, which may impact the quality of the company\u2019s investments.<\/p>\n
However, Krapful notes, \u201cThe many pros outweigh the cons associated with the move.\u201d<\/p>\n
Krapful advises investors to hold the stock.<\/p>\n
Hear more from analyst Jim Krapful:<\/span><\/p>\n