It has been about a month since the last earnings report for Illinois Tool Works (ITW). Shares have lost about 0.1% in that time frame, underperforming the market.
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 the most recent earnings report in order to get a better handle on the important catalysts.
Second-Quarter 2018 Highlights
Illinois Tool Works has delivered weaker-than-expected results for second-quarter 2018, lagging both earnings and sales estimates by 0.5%.
This industrial tool maker's earnings in the quarter were $1.97 per share, underperforming the Zacks Consensus Estimate of $1.98. However, the bottom line increased 17% year over year or improved 19%, excluding 3 cents per share of benefit from legal settlements realized, in the second quarter of 2017.
The year-over-year improvement came on the back of sales growth, benefits from enterprise initiatives and a 2.5% fall in the company's share count.
Revenues Gain From Segmental Strength
Illinois Tool Works generated revenues of $3,831 million in the reported quarter, reflecting growth of 6.5% from the year-ago tally. The improvement came on the back of 3.7% organic gains and 2.8% positive impact of foreign currency movements.
However, the top line lagged the Zacks Consensus Estimate of $3,852 million.
Illinois Tool Works reports its revenues under the segments discussed below:
Test & Measurement and Electronics' revenues in the second quarter increased 6.7% year over year to $554 million. Revenues from Automotive OEM (Original Equipment Manufacturer) grew 7.2% to $879 million. Food Equipment generated revenues of $553 million, increasing 4.8% year over year.
Welding revenues were $440 million, surging 14.3% year over year. Construction Products' revenues were up 4.4% to $444 million while revenues of $522 million from Specialty Products reflect growth of 6.5%. Polymers & Fluids’ revenues of $445 million increased 1.7% year over year.
In the reported quarter, Illinois Tool Works' cost of sales increased 6.9% year over year to $2,231 million. It represented 58.2% of the quarter’s revenues versus 58% in the year-ago quarter. Selling, administrative, and research and development expenses grew 2.8% year over year to $620 million while came in at 16.2% of revenues versus 16.8% in the year-ago quarter.
Operating margin was 24.3%, increasing 10 basis points (bps) year over year or improving 50 bps, excluding the impact of gains from the legal settlement in the second quarter of 2017. Enterprise initiatives contributed 110 bps to operating margin, offsetting a 70-bps adverse impact from unfavorable price/costs.
Balance Sheet and Cash Flow
Exiting the second quarter, Illinois Tool Works had cash and cash equivalents of $1,628 million, down 16.1% from $1,940 million recorded at the end of the last reported quarter. Long-term debt decreased 11.9% sequentially to $6,069 million.
In the second quarter, the company generated net cash of $620 million from its operating activities, reflecting growth of 33.6% over the year-ago quarter. Capital spending on the purchase of plant and equipment was $87 million, higher than $77 million used in the year-ago quarter. Free cash flow was $533 million, reflecting year-over-year growth of 37.7%.
During the second quarter, the company bought back $500 million of its common shares.
For 2018, Illinois Tool Works revised down its earnings guidance from $7.60-$7.80 to $7.50-$7.70 per share, reflecting growth of 15 cents at mid-point. The revision included 12 cents of adverse foreign currency translation impact predicted for the second half of 2018.
For the top line, the company anticipates a healthy business portfolio and a strengthening demand for products to support organic revenue growth of 3-4% (guidance maintained). Total revenues are anticipated to increase 4-5% year over year to $14.9-$15.1 billion.
The company revised down its operating margin projection from 25-25.5% to 24-25%, mainly due to margin dilution caused by price/costs. Also, the company noted, on a dollar basis, the adverse impact of cost increases will be offset by pricing actions. Enterprise initiatives are predicted to contribute more than 100 bps to the operating margin.
The expected tax rate is roughly 25%. Free cash flow will likely be roughly 100% of net income. Share buybacks are anticipated to be roughly $1.5 billion in the year.
For third-quarter 2018, earnings per share are expected to be $1.80-$1.90 versus $1.85 or $1.71 (excluding 14 cents per share benefit recorded from the legal settlement) generated in the year-ago quarter. Organic revenue growth is expected to be 3-4% while total revenues are anticipated to grow 2-3%.
How Have Estimates Been Moving Since Then?
In the past month, investors have witnessed a downward trend in fresh estimates.
At this time, Illinois Tool Works has a nice Growth Score of B, a grade with the same score on the momentum front. Charting a somewhat similar path, the stock was also allocated a grade of C on the value side, putting it in the middle 20% 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.
Based on our scores, the stock is equally suitable for growth and momentum investors while value investors may want to look elsewhere.
Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, ITW has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
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