ITW Comes to Party Early, Stays Late

Although it feels as though the economy has been in a recovery for quite a few quarters, in some circles the pickup is just beginning.

Consider Illinois Tool Works (ITW - commentary - Cramer's Take): Its sales have been in positive territory for seven consecutive months in a row, but the rate of increase is accelerating. And while roughly 40% of ITW sales are tied to autos and housing -- sectors that typically are considered early movers in an economic recovery -- another half are tied to business capital spending, which is just now picking up.

This early cycle exposure has helped the stock's performance this year. The shares are up more than 9% so far, slightly outpacing the 8% gain in the Dow Jones Diversified Industrials index, as well as the roughly flat return for the S&P 500. But ITW typically outperforms as the economic cycle matures, as well. Beyond that, the stock's valuation suggests there could still be more upside. Trading at a price-to-earnings ratio of 18 based on the consensus estimate of $5.10 for 2005, ITW currently is valued below its historical average forward P/E ratio of 20.

Third-quarter results also could give the shares a boost. At the very least, ITW's top-line growth could surprise on the upside. Last week, the company announced that its revenue rose 16% for the three months ending Aug. 31, with base revenue growth of 9% (excluding acquisitions and currency benefits). That August figure marked the seventh consecutive month of increases.

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The 9% rise also represents an acceleration from July's 8% growth rate that puts the quarter-to-date average comfortably ahead of management's guidance for growth of 6.5% to 8.5%. Even so, with the release of the sales data, ITW confirmed its earlier third-quarter and full-year earnings guidance of $1.05-$1.11 and $4.21-$4.35 per share, respectively.

But more important for the next few quarters are ITW's later cycle businesses. Those businesses rely mainly on business capital spending and have shown the most strength recently. For example, the North American Engineered Products segment, which serves mainly the early cycle construction and auto markets, delivered sales growth of 8% for the three months ending Aug. 31. North American Specialty Systems, which includes later cycle food equipment, packaging and welding systems, rose 14%, with welding equipment alone up 30%. ITW also is reportedly getting higher pricing in many of its business segments. That should help alleviate the bite out of earnings from higher raw material costs, one reason management has stayed on the conservative side with its earnings guidance.

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At the time of publication, Galli was long/short Illinois Tool Works, although holdings can change at any time.

Odette Galli is a freelance columnist for RealMoney.com. She has been a writer at SmartMoney Magazine and a senior manager at Ark Asset Management, where she co-managed $3 billion in institutional assets. In addition, Galli was a senior vice president at J & W Seligman. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. She welcomes your feedback and invites you to send your comments to [e-mail].