Illinois Tool Must Work Harder

NEW YORK (TheStreet) -- With shares of Illinois Tool Works (ITW) at near 52-week highs, investors are still celebrating management's five-year strategic plan provided back in December. Although management continues to do a great job executing ahead of the plan, I wouldn't get too excited here just yet.

I have always regarded Illinois Tool as a high-quality industrial name. I just don't believe that revenue growth has come in sufficient quantities - not unlike other industrial conglomerates like General Electric (GE) and Dover (DOV). Plus, on an organic growth basis, Illinois Tool has now posted several consecutive quarters of underperformance. And it doesn't appear that this will be fixed anytime soon.

Organic growth, which measures a company's operational performance using only internal resources and excluding events like acquisitions, is an important metric used to gauge performances of companies that are so well diversified. To that end, given Illinois Tool's breadth of end-market exposure, which includes food equipment, welding, automotive and electronics - areas that have been built via mergers and acquisitions, it's a worthwhile metric.

Secondly, I won't deny that management has done well from the standpoint of profitability. Margins have perked up over the past couple of quarters leading to a profit of $1.27 billion in the October quarter. Unfortunately, this represented a 33% year-over-year decline. And this was even with margin benefits coming from divestments of the decorative surfaces business. Not to mention, any advantages the company realized from the ongoing restructuring.

Despite all of this, I find it remarkable that Illinois Tool stock is near 52-week highs. I realize the company has always enjoyed a certain premium for its quality over the years. There's nonetheless plenty of risk in these shares as all of the good news is now priced in.


Don't mistake what I'm saying as an explicit "sell" recommendation. I just don't believe that the company's 9-month revenue performance of $10.6 billion, which is down 6.5% year over year, should be ignored. Investors argue about the adverse effects of the decorative surfaces divestment. I'm not discounting that. Still, when that business is adjusted out, Illinois Tool still lagged its peers on an organic basis.

Last but not least, in its various end markets, the company is not showing as much leverage as the Street believes is has. It's true that Illinois Tool continues to perform well in areas like automotive, particularly from an organic growth perspective. So has Honeywell (HON). And Illinois Tools continues to be hampered in areas like polymers and fluids.

What's more, unlike Honeywell and General Electric, I believe Illinois Tool lacks the sort of offsetting advantage that would be presented if it were more exposed to areas like aviation. In other words, the company would still be able to produce growth even amid weak periods in construction and electronics markets.

That the shares are nonetheless 5% up since management's performance update suggest that investors don't care much about these sort of details. Worse, the recent optimism assumes that General Electric, Dover and Honeywell will make no strategic adjustments of their own to stunt Illinois Tool's 5-year plan. I don't need to tell you that five years is a long time.

Tuesday, the company will report fourth-quarter and full-year results. The Street will be looking for earnings-per-share of 91 cents on revenue of $3.52 billion, which would represent a year-over-year revenue decline of 16.5%. Here again, I don't want to exaggerate the magnitude of a 16% revenue decline. But it's a 16% revenue decline. I don't know of any other way to say it.

The five-year plan is all well and good. And I also appreciate the margin improvement seen as a result of the ongoing restructuring. It shouldn't, however, absolve management from any near-term growth expectations - much less from company shares are trading with growth already priced in. All told, other than the 2% dividend yield, there's no compelling reason to buy this stock until revenue growth returns.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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