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Why Is Illinois Tool Works (ITW) Down 7.7% Since Last Earnings Report?

Zacks Equity Research

A month has gone by since the last earnings report for Illinois Tool Works (ITW). Shares have lost about 7.7% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Illinois Tool Works due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.

Illinois Tool Beats on Q2 Earnings, Lowers Organic View

Illinois Tool has delivered better-than-expected results for second-quarter 2019, with positive earnings surprise of 1.5%. This was the fourth consecutive quarter of impressive results.

This industrial tool maker's earnings in the reported quarter were $2.00 per share, surpassing the Zacks Consensus Estimate of $1.97. On a year-over-year basis, the bottom line increased 1.5% from the year-ago figure of $1.97, driven by margin improvement and a 3.6% fall in share count.

Notably, high restructuring expenses had an adverse impact of 2 cents on earnings while forex woes lowered the same by 6 cents and loss of divestitures had negative influence of 1 cent per share.

Revenues Decline Y/Y

Illinois Tool generated revenues of $3,609 million in the reported quarter, reflecting a decline of 5.8% from the year-ago figure. A 2.7% impact of unfavorable foreign currency movement, 0.3% owing to acquisitions/divestitures and 2.8% drop in organic sales (due to weak demand) affected top-line results. Product Line Simplification initiatives had adverse 0.7% impact on organic sales.

Further, the top line lagged the Zacks Consensus Estimate of $3,735 million by 3.4%.
 
Illinois Tool reports revenues under the segments discussed below:

Test & Measurement and Electronics' revenues in the second quarter decreased 3.6% year over year to $533 million. Revenues from Automotive OEM (Original Equipment Manufacturer) declined 10.4% to $788 million. Food Equipment generated revenues of $548 million, decreasing 1% year over year.

Welding revenues were $422 million, declining 4.2% year over year. Construction Products' revenues were down 4.5% to $424 million while revenues of $473 million from Specialty Products reflect a decline of 9.3%. Polymers & Fluids' revenues of $427 million decreased 3.9% year over year.

Operating Margin Improves

In the reported quarter, Illinois Tool's cost of sales decreased 5.9% year over year to $2,099 million. It represented 58.2% of the quarter's revenues, flat on a year-over-year basis. Selling, administrative, and research and development expenses decreased 3.5% year over year to $598 million while were 16.6% of the second quarter's revenues.

Operating margin (excluding restructuring charges) was 24.4%, increasing 10 bps year over year. Enterprise initiatives contributed 110 bps to operating margin, offsetting 60 bps of adverse impacts of volume and 40 bps from other sources.

Balance Sheet and Cash Flow

Exiting the second quarter, Illinois Tool had cash and cash equivalents of $1,677 million, down 4.4% from $1,755 million recorded at the end of the last reported quarter. Long-term debt increased 30.6% sequentially to $7,809 million.

In the second quarter, the company generated net cash of $685 million from operating activities, reflecting growth of 10.5% from the year-ago quarter. Capital spending on the purchase of plant and equipment was $77 million, lower than $87 million used in the year-ago quarter. Free cash flow was $608 million, reflecting year-over-year growth of 14.1%. In the quarter, the company bought back $375 billion worth of common shares.

Outlook

Illinois Tool noted that its performance in the second half of 2019 will be better than the first half, driven by favorable price/cost impact and enterprise initiatives. However, concerns over demand level compelled the company to lower its organic sales projection for the year.

For 2019, it lowered GAAP earnings guidance from $7.90-$8.20 to $7.55-$7.85 per share. The mid-point of the revised projection is $7.70, including the adverse impacts of 25 cents from higher restructuring and forex-related headwinds.

The company anticipates organic revenues to decline 1-3%, down from growth of 0.5-2.5% mentioned previously. Adverse impact of 80 bps is expected from PLS activities. Total revenues will likely be $14.3-$14.5 billion, down from previously stated $14.5-$14.8 billion.

The company expects operating margin (excluding restructuring activities) to increase roughly 25-75 bps year over year. The results will likely gain from 100 bps of contributions from enterprise initiatives while price/costs impact will improve.

The expected tax rate is roughly 24-25% versus the earlier given 24.5-25.5%. Free cash flow will likely be more than 100% of net income. It is likely to buy back shares worth roughly $1.5 billion in the year.

How Have Estimates Been Moving Since Then?

It turns out, estimates revision have trended downward during the past month.

VGM Scores

Currently, Illinois Tool Works has a nice Growth Score of B, a grade with the same score on the momentum front. However, the stock was allocated a grade of D on the value side, putting it in the bottom 40% for this investment strategy.

Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. It's no surprise Illinois Tool Works has a Zacks Rank #4 (Sell). We expect a below average return from the stock in the next few months.



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