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Neutral on Illinois Tool Works

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We recently maintained our Neutral recommendation on Illinois Tool Works Inc. (ITW - Free Report) . We expect the company to perform in line with the broader market.

Why Neutral?

Illinois Tool Works is one of the leading manufacturers of industrial products and equipments. The company provided a solid year-to-date return of 27.1% and is expected to boost earnings by 9.3% in the next 5 years.

Having said that, development of new and improved products as well as broadening the application of established products is becoming increasingly difficult for Illinois Tool Works in a growing competitive environment. Also, the company’s complex and fragmented business structure is proving to be an obstacle to growth. To combat this situation and to ensure maximum leverage from its core capabilities, Illinois Tool Works adopted a long-term Enterprise Strategy (2012-2017) in 2012.

The long-term Enterprise Strategy includes Business Simplification, Strategic Sourcing and Portfolio Management. In the fourth quarter 2013, these initiatives contributed roughly 110 basis points to Illinois Tool Works’ operating margin improvement. Cost savings in the range of $600–$800 million are expected from business structure simplification and strategic sourcing strategies. By the end of 2014, the company aims at divesting roughly 25% of 2011 revenue.

Also, Illinois Tool Works follows a consistent policy of returning value to its shareholders via dividend payments and share buybacks. In 2013, roughly $700 million was paid as dividends and $2.2 billion used for share buybacks while roughly $700 million and $1.8 billion are expected to be used for dividend payments and share buybacks in 2014. Spending on acquisitions is expected to be $375 million.

A brief snapshot of Illinois Tool Works’ fourth quarter 2013 results has been provided below.

Earnings per share in the quarter were 92 cents, up 41.5% year over year and above the Zacks Consensus Estimate of 91 cents. Revenue grew 4.8% driven by solid performances in North America, China, Australia and New Zealand. Segmental performance was impressive, except for the revenue decline in Polymers & Fluids and Construction Products segments. Operating margin expanded 260 basis points, aided by a 110 basis point contribution from Enterprise Strategic initiatives.

For 2014, earnings per share are predicted to be within $4.30–$4.50 range and revenue growth is expected in a band of 2%-4%, including organic growth of 2%-3%.  The Zacks Consensus Estimate for 2014 stands at $4.46 and Earnings ESP is at -0.22%. The company’s share price has fallen 2.8% since the earnings release on Jan 28, 2014.

Stocks to Consider

Illinois Tool Works currently has a $33.6 billion market capitalization and carries a Zacks Rank #3 (Hold). Some better-ranked stocks in the industry include Middleby Corp. (MIDD - Free Report) , Altra Industrial Motion Corp. (AIMC - Free Report) and Barnes Group Inc. (B - Free Report) . All these companies hold a Zacks Rank #2 (Buy).

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