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We currently maintained a Neutral recommendation on Illinois Tool Works Inc. (ITW - Analyst Report) anticipating the company’s performance in the next 6-12 months to be in line with the broader market.

Why Neutral?

Illinois Tool Works is one of the leading manufacturers of industrial products and equipment. The company focuses on growth across nations and hence adopted three strategic initiatives towards the effort. The first, Portfolio Management through meaningful acquisitions and disposition of non-strategic businesses has proved very advantageous.

Divestment of Decorative Surfaces segment in the fourth quarter 2012 was in line with Illinois Tool’s strategic initiative. In addition to divestment, meaningful acquisitions remain a preferred manner of expansion; the company spent roughly $95 million on acquisitions for annualized acquired revenue of approximately $130 million in the first half of 2013.

Other strategic initiatives aimed at long-term growth include Business Simplification and Strategic Sourcing. These three initiatives contributed roughly 60 basis points to the company’s operating margin improvement in the second quarter 2013.   
 
For a period from 2012 to 2017, Illinois Tool Works anticipates that organic growth would be about 200 basis points above industrial production. Operating margins and return on invested capital would be above 20% by 2017; while there would be 100% free cash flow conversion and 12% earnings per share CAGR beyond 2017. The company also remains committed on rewarding its shareholders through stock repurchases and dividend payments.

Notwithstanding these long-term aspects, we are concerned about Illinois Tool’s near-term headwinds. International operations expose the company to geo-political, currency translation risks, among many others. The prevalent instability in the European market led to a 1.0% fall in organic revenue in the second quarter 2013.
 
Talking of Illinois Tool’s recently reported second quarter 2013 results, earnings per share managed 5.9% year over year increase but lagged behind the Zacks Consensus Estimate by a cent. Revenue plummeted 5.5% due to Decorative Surfaces divestiture, excluding which it grew 1%. Results in North America and Europe were weak, while China and Brazil recorded impressive growth.

For 2013, management of Illinois Tool remains wary of end market demand in some segments and has lowered its revenue growth guidance. Earnings outlook have also been lowered to account for dilution from the pension settlement charge.

Subsequent to the earnings release, the Zacks Consensus Estimate for 2013 has gone down by 0.7% to $4.20 and for 2014 the estimate has plummeted 0.4% to $4.66 in the last 7 days.

Others Stocks to Consider

Illinois Tool currently has a 32.2 billion market capitalization. Other stocks to watch out for are Gorman-Rupp Co. (GRC - Snapshot Report), with a Zacks Rank #1 (Strong Buy) while Chart Industries Inc. (GTLS - Snapshot Report) and Dover Corporation (DOV - Analyst Report), each hold a Zacks Rank #2 (Buy).

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