ITT: A Good Value in a Defensive Name

Jan.22.10 | About: ITT Corporation (ITT)
ITT Corporation (NYSE:ITT), is a diversified company engaged in the design, manufacture and sale of a range of engineered products. The Company’s three principal business segments are: Defense Electronics & Services, Fluid Technology and Motion & Flow Control. The Defense Electronics & Services segment provides high-technology electronic systems and components, communications systems plus engineering and applied research. Fluid Technology covers water and wastewater treatment systems, pumps and related technologies for residential, commercial and industrial applications. ITT’s Motion & Flow Control businesses provide products and services for defense, aerospace, industrial, transportation, computer, telecom and marine.
2009 is likely to have posted the first down earnings year in more than a decade. Even so, the dip is likely to be small- with EPS going from an all-time record $4.04 to about $3.74. The consensus view for this year is for a rebound to $4.00 /share.
Here are ITT’s [split adjusted] per share figures from continuing operations as reported by Value Line:
Year
Sales
C/F
EPS
Div.
B/V
Avg. P/E
52-wk. range
2000
27.47
2.65
1.47
0.30
6.89
10.8x
11.20-19.80
2001
26.33
2.78
1.55
0.30
7.75
14.4x
17.80-26.00
2002
27.15
2.82
1.86
0.30
6.19
16.9x
22.90-35.40
2003
30.49
2.99
1.93
0.32
10.01
16.1x
25.10-37.70
2004
36.65
3.45
2.27
0.34
12.69
17.5x
35.50-43.40
2005
40.23
3.76
2.70
0.36
14.75
18.1x
40.20-58.10
2006
42.95
4.00
2.85
0.42
15.76
18.4x
45.30-58.70
2007
49.59
4.60
3.53
0.53
21.73
18.1x
56.30-73.40
2008
64.33
5.61
4.04
0.67
16.83
13.9x
34.80-69.70
2009*
59.55
5.35
3.74
0.81
20.14
12.3x
31.94-56.95
Click to enlarge
* 2009 data includes consensus estimates for Q4
The company has been a stellar performer over the past 10 years as judged by its progress on all fundamental measures.
At Thursday afternoon’s price of $49.23 it was offered at just 13.2x trailing and about 12.1x projected 2010 earnings. That’s very low compared with their 10-year median P/E of 16x. A rebound to even a 15 multiple would bring ITT back to the $60 range by year end if the EPS estimates are on target.
The dividend has been raised in each of the past seven years and has grown by 172% since 2000. The current yield is 1.72% providing investors with a better than CD rate yield while we wait for the share price to revert to a more normalized valuation.
Is a $60 goal price reasonable? ITT shares actually changed hands at peak prices of $58.10 - $73.40 during each calendar year 2005, 2006, 2007 and 2008. Sales and earnings were lower than today during most of that period. Standard and Poors is carrying a 12-month target of $61 while assigning ITT their highest, 5-star ranking.
ITT receives an ‘A+’ financial strength rating from Value Line. VL also noted that ITT rates very high in terms of ‘stock price stability’, ‘price growth persistence’ and ‘earnings predictability’ with percentile rankings of 85th, 95th and 95th respectively (with 100th being best).
These high-quality shares appear to offer about 20% upside along with a decent yield.
If you’re comfortable with options trading you might want to consider this trade.
Cash Outlay
Cash Inflow
Buy 1000 ITT @ $49.23 /share
$49,230
Sell 10 ITT July $50 calls @ $3.00 /share
$3,000
Sell 10 ITT July $50 puts @ $4.00 /share
$4,000
Net Cash Out-of-Pocket
$42,230
Click to enlarge
If ITT shares move up to $50 or better (+1.6% from today’s quote) by July 16, 2010:
· The $50 calls will be exercised.
· You will sell your shares for $50,000.
· The $50 puts will expire worthless.
· You will have received $425 in dividends.
· You will have no further option obligations.
· You will end up with no shares and $50,425 in cash.
That’s a best-case profit of $50,425 - $42,230 = $8,195
$8,195/$42,230 = + 19.4% (achieved over the six-month holding period on shares that only needed to rise by 1.6% from trade inception)
If ITT shares remain below $50 on the July 16, 2010 expiration date:
· The $50 calls will expire worthless.
· The $50 puts will be exercised.
· You will be forced to buy an additional 1000 ITT shares.
· You will need to lay out another $50,000 in cash.
· You will have received $425 in dividends.
· You will have no further option obligations.
· You will end up with 2000 ITT shares plus $425 in cash.
What’s the break-even on the whole trade?
On the original 1000 shares it’s their $49.23 purchase price less the $3 /share call premium = $46.23 /share.
On the ‘put’ shares it’s the $50 strike price less the $4 /share put premium = $46 /share.
Your overall break-even would be $46.12 (excluding dividends). ITT shares could fall by up to $3.11 /share (-6.3%) without causing a loss on this trade.
Summary:
ITT shares look to be relatively low-risk stock that offers at least 20% upside over the next 12 months.
Buying shares and writing (selling) the $50 calls and puts for July would make any move back up to $50 or higher translate to a cash-on-cash return of > 19% over the next six months while providing a 6.3% margin of safety if things don’t go as expected.
Disclosure: Author is long ITT shares and short ITT options.