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Illinois Tool's (ITW) Organic Prospects Solid, Costs a Drag

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We issued an updated research report on Illinois Tool Works Inc. (ITW - Free Report) on Jul 2.

This machinery company currently carries a Zacks Rank #3 (Hold). Its market capitalization is approximately $46.9 billion.

Below, we briefly discussed the company’s potential growth drivers and possible headwinds.

Factors Favoring Illinois Tool

Growth Projections: Illinois Tool pulled off better-than-expected results in the last four quarters, with an average positive earnings surprise of 3.28%. Currently, the company’s Zacks Consensus Estimate is pegged at $1.97 for second-quarter 2018, $7.78 for 2018 and $8.43 for 2019, representing year-over-year growth of 18.7%, 18.1% and 8.4%, respectively.

In 2018, Illinois Tool anticipates gaining from strengthening demand, enterprise initiatives and a healthy business portfolio. It predicts earnings of $7.60-$7.80 per share, above the previous projection of $7.45-$7.65, reflecting year-over-year growth of 17% at mid-point. Organic sales growth is expected to be 3-4%.

Over the long term (2018-2022), Illinois Tool expects organic revenue growth to be 3-5%, operating margin to be in excess of 25%, incremental margin to be 35% and earnings per share to grow 8-10% in each year. Also, after-tax return on invested capital is projected to be above 20%.

Strategic Initiatives: Illinois Tool’s Enterprise Strategy — including Business Structure Simplification, Portfolio Management and Strategic Sourcing ??? has helped in maximizing profits through the development of improved products and reasonable cost control. These enterprise initiatives are likely to contribute 100 basis points to operating margin growth in 2018.

Moreover, the company believes in making investments to acquire businesses. It acquired Engineered Fasteners and Components in July 2016, which has been boosting the Automotive OEM business of the company since then.

Shareholder-Friendly Policy: Rewarding shareholders handsomely through dividend payments and share buybacks have always remained Illinois Tool’s priority. The company intends on increasing its dividend payout from 43% to 50% of free cash in August 2018. This increment, currently subjected to the company’s board approval, was earlier scheduled for 2020. Also, it is worth noting that the company hiked its quarterly dividend rate by 20% in August 2017 while it bought back $500 million worth shares in the first quarter of 2018.

Factors Working Against Illinois Tool

Threats From Global Uncertainties, Share Price Performance: Illinois Tool’s segmental results are highly correlated to industrial, automotive and housing markets of the countries it serves. Trade disputes and unfavorable governmental policies, as well as uncertainties in the global market, can be detrimental for the company. For instance, lower auto builds across the globe in the first quarter of 2018 adversely impacted the company’s Automotive OEM business.

Of late, market sentiments are not in favor of Illinois Tool. Its share price has plunged nearly 2% post the release of first-quarter 2018 results on Apr 26 while declined roughly 10.8% in the past three months. The three-month fall underperformed 5.6% decline recorded by the industry it belongs to.

Adversaries Arising From Rising Costs: Raw material cost inflation has been lately troubling Illinois Tool. The company’s operating margin in the first quarter of 2018 suffered from 50 bps adverse impact from price/costs. For the second quarter, the company predicts similar net impacts of pricing actions and raw material cost inflation on margins.

Long-Term Debt & Weak Cash Position: Illinois Tool is a highly leveraged company. In the last five years (2013-2017), the company’s long-term debt soared 21.8% (CAGR) while some respite came from 7.9% sequential fall recorded in the first quarter of 2018. However, the company’s long-term debt of $6.9 billion is concerning. Also, its total debt to total equity spiked from 65.3% in 2013 to 181.5% in 2017. It was at 181.3% in the first quarter of 2018.

Moreover, the company’s cash position has weakened over time. In the last five years (2013-2017), its cash and cash equivalents went down 3.1% (CAGR) while the same was down 37.3% sequentially in the first quarter of 2018.

Stocks to Consider

Some stocks worth considering in the industry are Twin Disc, Incorporated (TWIN - Free Report) , Kadant Inc. (KAI - Free Report) and Altra Industrial Motion Corp. (AIMC - Free Report) . While both Twin Disc and Kadant sport a Zacks Rank #1 (Strong Buy), Altra Industrial Motion carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

In the last 60 days, earnings estimates for each of these stocks have improved for the current year. Also, average positive earnings surprise for the last four quarters has been 250.43% for Twin Disc, 15.50% for Kadant and 5.06% for Altra Industrial Motion.

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