EUR 850.00 For Business Accounts Only

Morningstar | Market’s Negative Reaction to ITW’s Conservative Guidance Doesn’t Alter Our Long-Term Thesis

Narrow-moat Illinois Tool Works had a solid fourth quarter to round out the year, performing broadly in line with our expectations, and we don’t anticipate any material change to our $140 fair value estimate. We’re also retaining our narrow moat, medium uncertainty, and Exemplary stewardship ratings. Full-year sales rose to $14.8 billion, or 3% from last year, right in line with our expectations. Total GAAP operating income rose to $3.6 billion, or 3%, also in line with our expectations, while full-year diluted GAAP EPS came in at $7.60, exactly in line with our expectations.

Progress during the quarter was propelled by margin expansion of 70 basis points driven primarily by ITW's enterprise initiatives, while top-line momentum was driven by the firm’s welding (7% growth year over year) and food equipment (4% growth year over year) segments. Organic revenue growth of 8% year over year in welding was strong in both equipment and consumables, while international contributed 11% year-over-year growth. Food equipment, by contrast, saw greater growth in North America, up 7% year over year.

Offsetting top-line strength in these segments, however, was weakness in auto OEM, where revenue declined by 6% year over year, but we built this in to our own fourth-quarter projections. Construction products and specialty products also took it on the chin, with the latter lagging a little more than expected on the international front, with negative 8% year-over-year revenue growth. Even so, one of the quarter's three weaker performers in construction products was still able to offset top-line headwinds at the margin level with 150 basis points of margin expansion. Polymers and fluids segment and test and measurement/electronics segment also had appreciable margin expansion from last quarter at 160 and 140 basis points, respectively. We think these results confirm the strength of ITW’s 80/20 business model and its ability to drive margin expansion, even despite market headwinds.

We think the market paradoxically reacted negatively to the firm’s results because of modest guidance for 2019 (organic growth of 1% to 3% at current rates), which strikes us as prudent given whispers of a slowing macroeconomic environment. Nevertheless, we’re not as macro-focused, since our methodology relies on a bottom-up analysis of each of the segment’s major markets, which is how ITW runs its own business. As a result, while we expect to moderate our near-term projections, we’re not overly concerned despite the ebbs and flows of the market, and we think our long-term thesis for the stock remains intact.

For example, as the company did a great job detailing during its investor day, the firm’s products and services are designed to cut down on its customers' costs. Easy-to-use products, for example, cut down on training costs, which we consider important given reduced availability of skilled labor in the developed world, particularly in the United States. Nevertheless, while we have a positive view on the company, as underpinned by both our moat and stewardship ratings, we think the market has largely factored these assessments in to its stock price, and we recommend investors wait for a larger margin of safety before buying shares.