Illinois Tool Works (ITW) has captured my attention lately. It has shown up on one of my favorite screens, the high-quality growth dividend payers, which I shared recently. It also showed up on a screen I run for potential rebound candidates. It's not in my official watchlist, but I am monitoring it from a secondary watchlist that I maintain. I think that the stock is most suitable for large-cap core/growth investors.
The company has been around since WWI an operates 825 units in 8 divisions. I have personally reviewed each and every one of them - not. I think it is safe to say that they are extremely diversified, participating in many different markets and generating about 1/2 their sales from outside the U.S. The 8 operating segments include: Industrial Packaging, Power Systems & Electronics, Transportation, Construction Products, Food Equipment, Decorative Surfaces, Polymers & Fluids and Other. Digging in, it seems rather obvious that the residential construction bust has impacted the company. Margins have come down over 200 bps over the past couple of years and are projected to bottom out this year.
For a company that uses M&A strategically, the balance sheet is surprisingly strong. The company has equity of $9.25 billion, though $5.8 billion is intangible/goodwill. Total debt of $2.8 billion is offset somewhat by over $900mm in cash. Inventory growth over the past year has been in line with sales growth, and DSOs have been stable as well. The company generates tremendous free cash flow - $1.8 billion in 2007. The company has been aggressively repurchasing stock, reducing the float by 6% over the past year.
As you can see in the chart below, valuation is pretty generous these days, with a forward PE of just 13.5X. The dividend yield is more than 50% of the 10-year Treasury rate, which is extreme for the company. I included a panel showing the pre-tax margin. While a deep recession could certainly hit margins, it is important to realize that the PE is low despite margins already having compressed significantly (14.4% is the consensus forecast for 2008).
I don't think that ITW is necessarily the greatest industrial stock or that different from many other large-cap companies, but it sure helps illustrate how attractively priced stocks are. When I am buying stocks, I like to get a good price, as I believe is the case here, and also a sense that the stock is "working". In the case of ITW, it looks like it put in a double-bottom in the 45 area. The stock peaked recently at 55.5 and has retraced about 38% of the post-bottom move. Maybe it will drop a couple of more points (I would be surprised to see 49 not hold), but the stock definitely is showing good relative strength over the past 4 or 5 months. I also like to see the 50dma cross the 150dma, which is the case here. When I look out over the next year, I expect to see some PE expansion here. 15X the blend of the 2009 and 2010 estimates would yield a price a year from now of about 65 (a total return of about 29%). For now, I will continue to monitor this one, preferring to own names that I believe offer even more upside (see my holdings for examples).
Disclosure: Author has no position.
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