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We currently maintained a Neutral recommendation on Illinois Tool Works Inc. (ITW - Analyst Report) anticipating that the company would perform in line with the market. Long-term opportunities remain compelling for the stock but it is the near-term concerns that keep us on the sidelines.

Why Neutral?

Illinois Tool Works is one of the leading manufacturers of industrial products and equipment. The company operates in seven end markets across 57 countries. Decorative Surfaces segment was divested in the fourth quarter as part of the company’s strategic initiative to grow through disposition of non-core business. Besides, meaningful acquisitions also remain a preferred way for expansion; the company spent roughly $730 million on acquisitions for annualized acquired revenue of approximately $500 million in 2012.

Other strategic initiatives aimed at long-term growth include Business Simplification and Strategic Sourcing. The first strategy is expected to bring smaller revenue generation units having common products or line of business under one roof while the second initiative will enable the company to better manage its raw materials and other costs.

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.

Notwithstanding these long-term aspects, we are concerned about the company’s near-term headwinds. Negative impacts from foreign currency translation, which have reduced revenue by 2.7% in 2012, still remain a nagging concern.
 
Even the company’s fourth quarter results were disappointing. Earnings per share of 89 cents in the quarter were a cent below the Zacks Consensus Estimate. Revenue plummeted 2.3% year over year due primarily to the divestiture of Decorative Surfaces segment and negative foreign currency translation. Operating margin fell 60 basis points.

Near-term concerns and fourth quarter 2012 results had an impact on earnings estimates for the company. The Zacks Consensus Estimate for 2013 has gone down by 2.1% to $4.29 (8 of 13 estimates were revised downwards) and for 2014 the estimate has plummeted 1.4% to $4.81 (4 of the 13 estimates were lowered) in the last 30 days.

Others Stocks to Consider

Other stocks to watch out for are Altra Holdings, Inc. (AIMC - Snapshot Report), Atlas Copco AB (ATLKY) and Metso Corp. , each holding a Zacks Rank #1 (Strong Buy).
 

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