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Morningstar | ITW Reveals No New Surprises in Its 1Q 2019 Results as We Maintain Our FVE

Nothing about narrow-moat Illinois Tool Works’ first-quarter 2019 performance alters our long-term view of the firm. As a result, we plan to maintain our $141 fair value estimate as we update our model. Organic top-line growth was down 1.5% but flat on an equal days basis. That said, we had largely expected seasonal headwinds during the front of the year, which we expect to moderate as ITW moves to the back half of the year. Indeed, management reports that sales trends were already improving in March after a slow start in January. Therefore, we continue to model a 1% year-over-year top-line CAGR for the firm, net of the effect of dispositions.

We also expect a 100-basis-point improvement in 2019 operating margins. Net of restructurings, year-over-year operating margins expanded 20 basis points, but we expect this to improve once accelerating organic growth flows through during the back half of the year. The firm’s enterprise initiatives (which include applying the Pareto principle to the sourcing of its materials within its supply chain, for example) and improving price/cost (industrial jargon for a company’s ability to offset rising costs through price) helped drive most of this margin expansion. Finally, on the heels of these fundamental improvements, we expect a rise in ROIC, including goodwill, of about 140 basis points by the end of 2019 (from 2018 levels), in line with management’s guidance of plus or minus 200 basis points.

This quarter’s results saw a mix of puts and takes, with North America organic revenue up 1%, offset by international, which was down 1% year over year, all on an equal days basis. Given what we heard in previous calls earlier in the day from 3M and Rockwell, auto OEM sales, unsurprisingly, declined 6% year over year, as North America, Europe, and China were all down 5% year over year on an equal days basis. We’re not expecting much out of this segment for 2019, and we’ve already modeled slightly negative year-on-year growth.

There were, however, pockets of strength in the earning results, particularly in ITW’s capital-expenditure-driven businesses, including food equipment; test/measurement and electronics; and welding. Sales rose 3% year over year on an equal days basis in the food equipment segment, as growth in independent restaurants and quick-service restaurants was solid. Management highlighted food retail, which saw double-digit rates of year-over-year growth coupled with a sequential recovery.

While test and measurement grew only 1% year over year on an equal days basis, that was off a very difficult comparison, since the segment grew 8% year over year organically in 2018’s first quarter. Welding, which may be our favorite ITW business and the one we’re most bullish on, saw year-over-year sales rise 5% on an equal days basis. What’s most impressive about this result is that this was off a tough 8% year-over-year rise in last year’s revenue, as well as a two-day shutdown of ITW’s main operations in Wisconsin during the earlier parts of the year. China in particular offered welding double-digit gains, which fits neatly with our thesis that increasing investment in infrastructure development in economies like China and the rest of the Asia-Pacific region will drive significant growth in this segment over the next five years.