Investors in Illinois Tool Works (ITW) are having a solid end to an already good year. The company updated the market on its strategic plans and issued a solid outlook for 2014, implying further earnings growth.
As the market already has priced in a lot of good news, I am a bit more cautious and stay on the sidelines, after earnings multiples have increased on the back of better visibility for future earnings.
Illinois Tool Works updated the market with its progress on the 5-year strategic plan.
The company reconfirmed its full year target for earnings of $3.56-$3.64 per share for 2013. The company sees solid growth into next year, with earnings seen between $4.30 to $4.50 per share, based on organic sales growth of 2 to 3%.
Last year, Illinois Tool Works outlined its 2012-2017 strategy at its Analyst Meeting. The company made good progress this year, the first year under its five-year plan. The company expects to perform strong in 2014 as well, with operating margins approaching 19%.
The company focuses on the Pareto principle in the business, knowing that 20% of the focus and efforts results in 80% of the returns and earnings. The focus with this is on operating margins and capital efficiency, resulting in strong return on capital.
Back in October, Illinois Tool Works reported its third quarter results. The company operates with $3.02 billion in cash and equivalents and $5.14 billion in debt, resulting in a net debt position of $2.12 billion.
Reported revenues for the first nine months of the year came in at $10.58 billion, down 6.5% on the year before. Note that when adjusting for the divestiture of its decorative surfaces, revenues would have been up.
Reported earnings came in at $1.27 billion, down 32.8% on the year before. Last year, the company reported income of $579 million from discontinued operations. Adjusting for this, earnings fell slightly compared to last year.
At this pace, annual revenues are seen around $14 billion, while earnings are seen around $1.6 billion.
Trading around $80 per share, the market values Illinois Tools Works at $35.7 billion. This values equity in the firm at 2.5 times annual revenues and 22 times annual earnings.
The company currently pays a quarterly dividend of $0.42 per share, for an annual dividend yield of 2.1%.
Some Historical Perspective
Long-term holders in Illinois Tool Works have seen modest to solid returns. Over the past decade, shares have traded in a $30-$60 trading range. Solid momentum this year has resulted in shares breaching out of the upper range, increasing to highs of $80 at the moment.
Between 2009 and 2013, Illinois Tool Works increased its annual revenues very modestly towards $14 billion on the back of the divestment last year. Earnings have risen from just below the $1 billion mark in 2009 to an expected $1.6 billion this year. Note that earnings were higher last year, but were largely driven by one-time gains related to the sale of businesses.
The company added to the returns for its shareholders by repurchasing some 10% of its shares over this time period.
Investors are pleased with Illinois Tool Works, and in particular its management. The company's focused strategy has boosted organic sales growth, but more importantly it has resulted in higher margins which combined is a strong mix to improve earnings.
Having just started its ambitious plan a year ago, the company is well positioned to see further growth, seeing strong earnings growth in 2014, which brings the valuation multiple down to 18 times annual earnings.
The company, which is active in automotive, test and measurement electronics, food equipment, welding, construction products and specialty products, sees solid growth through 2017. Market growth, an organic outperformance of 200 basis points per annum, combined with selective deals should boost topline revenue growth. Combined with operating margins exceeding 20%, earnings should see a further boost.
These improving earnings, combined with the proceeds from the divestiture of the decorative activities, have resulted in strong shareholder payouts so far this year. Shareholders already received $1.6 billion in returns through repurchases and dividends in the first nine months of this year, with the company paying out equivalent 6% of its current valuation per annum.
Shares of the company have seen a real boost from the outlined program, which has been supported by real profit growth already, and results in a strong outlook for 2014. Yet the momentum has pushed up shares and the earnings multiple as well, as investors have been bidding up shares on the back of increased visibility for future earnings.
While the company and management has done a great job so far, boosting value under its 80/20 Pareto rule, the market has already priced in these improvements to a large degree. Therefore, I remain a bit more cautious and stay on the sidelines.