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Here's Why You Should Hold on to Illinois Tool Stock Now

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We issued an updated research report on Illinois Tool Works Inc. ITW on Sep 6.

This industrial machinery maker’s market capitalization is approximately $47.4 billion. It currently carries a Zacks Rank #3 (Hold).

Few growth drivers, as well as certain headwinds, which might influence Illinois Tool, have been discussed below.

Factors Favoring Illinois Tool

Initiatives Aiding Organic Growth & Margins: Illinois Tool’s Enterprise Strategy — Business Structure Simplification, Portfolio Management and Strategic Sourcing — has been proving beneficial since introduced in 2012.

Business Structure Simplification and Portfolio Management strategies have helped in strengthening the company’s organic growth trajectory. Organic sales increased 0.2% in 2013 while expanded 3% in 2017. On the other hand, Strategic Sourcing has helped in managing raw materials and other costs, and benefitted margins. During 2013-2017, annual costs have been reduced by 1% through Strategic Sourcing and similar results are anticipated in 2018 as well.

It’s worth noting here that Enterprise Strategy is anticipated to add in excess of 100 basis points to operating margin in 2018.

Rewards for Shareholders: Illinois Tool is an ardent believer in rewarding shareholders handsomely, especially through dividend payments. In the first half of 2018, the company used $530 million cash for distributing dividends to shareholders while repurchased shares worth $1 billion.

It’s worth mentioning here that the company has hiked its quarterly dividend rate by 28% in August 2018. Also, it communicated the approval of a $3-billion share buyback program. This new authorization, along with $1.4 billion left from the earlier $6-billion buyback program (approved in February 2015), allows the company to repurchase up to $4.4 billion of its common shares.

Top-Line Projections: A diversified business structure, healthy product portfolio and strengthening demand in end markets will help in boosting Illinois Tool’s top line in the quarters ahead. Investments in innovating products, and tapping customer demand in existing and new markets will also be beneficial.

For 2018, the company anticipates total revenues to grow 4-5% year over year to $14.9-$15.1 billion. This guidance includes organic sales growth of 3-4%.

Factors Working Against Illinois Tool

Weak Margins: Raw material cost inflation can be a drag on Illinois Tool’s margins. This inflationary impact reduced operating margin by 70 basis points in the second quarter of 2018.

For 2018, the company believes that the impact of cost inflation will be negated by pricing actions on a dollar basis. However, its adverse impact on margins cannot be avoided. The company now estimates operating margin to be 24-25%, below 25-25.5% expected earlier.

Forex Woes, Weak Earnings Guidance: Despite reflective of a flourishing business, geographical diversification has exposed Illinois Tool to headwinds, arising from geopolitical issues and unfavorable movements in foreign currencies. The company predicts foreign currency translations to hurt its bottom line by 12 cents per share in the second half of 2018. For 2018, it now anticipates earnings per share of $7.50-$7.70, below $7.60-$7.80 expected earlier.

Sentiments currently seem to be weak for Illinois Tool. In the past 60 days, earnings estimates on the stock for 2018 has been lowered by nine brokerage firms while the same for 2019 have been decreased by seven firms. Currently, the Zacks Consensus Estimate for earnings is at $7.64 for 2018 and $8.27 for 2019, reflecting decline of 1.8% and 1.95 from the respective tallies 60-days ago.

Further, the company’s price has declined 4.6% in the past three months, underperforming 4.8% growth recorded by the industry.

Weak Cash Position, High Debts: We believe that weak cash position and highly leveraged balance sheet can be concerning for Illinois Tool. Its cash and cash equivalents have decreased 3.1% (CAGR) in the last five years (2013-2017) while fell 37.3% in the first quarter of 2018 from the balance at the end of 2017.

Also, the company’s long-term debts have grown 21.8% (CAGR) in the last five years. So far, in 2018, sequential declines of 7.9% in the first quarter and 11.9% in the second quarter have been registered. Despite this, the debt balance was as high as $6.9 billion at the end of the second quarter of 2018, with total debt to total equity of 195.9%.

Stocks to Consider

Some better-ranked stocks in the industry are Altra Industrial Motion Corp. AIMC, Colfax Corporation CFX and DXP Enterprises, Inc. DXPE. All these stocks sport a Zacks Rank #1 (Strong 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 4.01% for Altra Industrial Motion, 7.91% for Colfax and 101.32% for DXP Enterprises.

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