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Why Is Illinois Tool Works (ITW) Down 6.6% Since its Last Earnings Report?

Zacks Equity Research
Investors certainly have to be happy with Stitch Fix, Inc. (SFIX) and its short-term performance

A month has gone by since the last earnings report for Illinois Tool Works Inc. ITW. Shares have lost about 6.6% in that time frame, underperforming the market.

Will the recent negative trend continue leading up to its next earnings release, or is ITW due for a breakout? Before we dive into how investors and analysts have reacted 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.

Fourth-Quarter 2017 Highlights

Illinois Tool Works kept its earnings streak alive in fourth-quarter 2017, pulling off a positive earnings surprise of 4.9%. Results were primarily driven by sales growth, benefits from enterprise initiatives and 2.4% fall in the diluted share count due to the company's active share buyback activities.

Earnings, excluding roughly $1.92 per share of tax charge in the quarter, came in at $1.70 per share, topping the Zacks Consensus Estimate of $1.62. The bottom line increased roughly 17% from the year-ago tally of $1.45.

For 2017, the company's earnings were $6.59 per share, lagging the Zacks Consensus Estimate of $6.70. However, the figure grew 16% year over year. As noted, the bottom-line results excluded roughly 17 cents benefit accrued from a legal settlement and $1.90 per share of tax charge.

Revenues Driven By Organic and Forex Gains

Revenues in the quarter totaled $3,629 million, reflecting growth of 7% from the year-ago tally. The improvement was driven by 3.7% organic gains and 3.2% positive impact of foreign currency movements, partially offset by 0.1% negative impact from acquisitions/divestitures.

Also, the top line surpassed the Zacks Consensus Estimate of $3.55 billion.

Illinois Tool Works reports its revenues under the segments discussed below:

In the quarter, Test & Measurement and Electronics' revenues increased 11.7% year over year to $545 million. Revenues from Automotive OEM (Original Equipment Manufacturer) grew 7% to $828 million. Food Equipment generated revenues of $548 million, increasing 3% year over year.

Welding revenues came in at $388 million, growing 7.4% year over year. Construction Products' revenues were up 6.7% to $412 million while revenues of $487 million from Specialty Products reflected growth of 6.9%. Polymers & Fluids' revenues of $427 million increased 4.9% year over year.

For 2017, the company's revenues totaled approximately $14,314 million, increasing 5.3% year over year. Also, the figure surpassed the Zacks Consensus Estimate of $14.2 billion.

Margin Profile Improves

In the quarter, Illinois Tool Works' cost of sales increased 5.9% year over year, representing 58.5% of total revenues compared with 59% in the year-ago quarter. Selling, administrative, and research and development expenses, as a percentage of total revenues, came in at 16.7%.

Operating margin improved 160 basis points (bps) year over year to 23.4%, driven by roughly 140 bps contributions from enterprise initiatives.

Cash Position Strong, Debt Increases Slightly

Exiting the fourth quarter, Illinois Tool Works had cash and cash equivalents of approximately $3,094 million, up from $2,785 million in the previous quarter. Long-term debt was $7,478 million versus $7,439 million in the previous quarter.

The company generated net cash of $695 million from its operating activities in the quarter, up 4.7% year over year. Capital expenditure on purchase of plant and equipment totaled $78 million. Free cash flow was $617 million, reflecting a conversion rate (as a percentage of adjusted net income) of 106%.

Outlook

For 2018, Illinois Tool Works increased its GAAP earnings guidance to $7.45-$7.65 per share, reflecting 40 cents growth at mid-point. The increase reflects the positive impact of tax rate cuts to 25-26% and forex gains. Revenues are anticipated to be $15-$15.2 billion, reflecting year-over-year growth of 5-6%. Organic growth is expected to be 3-4%. Operating margin is estimated to be 25-25.5%, including 100 basis points from enterprise initiatives.

For first-quarter 2018, GAAP earnings per share are expected within $1.80-$1.90. Organic revenues are expected to be 3-4%.

In addition to these, the company declared its intention to increase the dividend payout rate from 43% to 50% of free cash in August 2018. However, this increment is still subject to the company's board approval.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in fresh estimates. There have been three revisions higher for the current quarter. In the past month, the consensus estimate has shifted by 7.3% due to these changes.

VGM Scores

Currently, ITW 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 F on the value side, putting it in the fifth quintile for this investment strategy.

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

Zacks' style scores indicate that the company's stock is suitable for growth and momentum investors.

Outlook

Estimates have been trending upward for the stock and the magnitude of these revisions looks promising. It comes with little surprise that ITW has a Zacks Rank #2 (Buy). We expect an above average return from the stock in the next few months.


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