Company Description: Illinois Tool Works Inc. is a diversified manufacturer that operates a portfolio of 60 business units that serve industrial and consumer markets globally.
Fair Value: In calculating fair value, I consider the NPV MMA Differential Fair Value along with these four calculations of fair value, see page 2 of the linked PDF for a detailed description:
1. Avg. High Yield Price
2. 20-Year DCF Price
3. Avg. P/E Price
4. Graham Number
ITW is trading at a discount to only 3.) above. The stock is trading at a 30.4% premium to its calculated fair value of $67.46. ITW did not earn any Stars in this section.
Dividend Analytical Data: In this section there are three possible Stars and three key metrics, see page 2 of the linked PDF for a detailed description:
1. Free Cash Flow Payout
2. Debt To Total Capital
3. Key Metrics
4. Dividend Growth Rate
5. Years of Div. Growth
6. Rolling 4-yr Div. > 15%
ITW earned one Star in this section for 1.) above. A Star was earned since the Free Cash Flow payout ratio was less than 60% and there were no negative Free Cash Flows over the last 10 years. The company has paid a cash dividend to shareholders every year since 1933 and has increased its dividend payments for 51 consecutive years.
Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA) or Treasury bond? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:
1. NPV MMA Diff.
2. Years to > MMA
The NPV MMA Diff. of the $296 is below the $500 target I look for in a stock that has increased dividends as long as ITW has. If ITW grows its dividend at 7.1% per year, it will take 6 years to equal a MMA yielding an estimated 20-year average rate of 2.98%.
Memberships and Peers: ITW is a member of the S&P 500, a Dividend Aristocrat, a member of the Broad Dividend Achievers™ Index and a Dividend Champion. The company's peer group includes: The The Manitowoc Company, Inc. (MTW) with a 0.4% yield, Timken Co. (TKR) with a 2.5% yield and Highway Holdings Limited (HIHO) with a 6.7% yield.
Conclusion: ITW did not earn any Stars in the Fair Value section, earned one Star in the Dividend Analytical Data section and did not earn any Stars in the Dividend Income vs. MMA section for a total of one Star. This quantitatively ranks ITW as a 1-Star Very Weak stock.
Using my D4L-PreScreen.xls model, I determined the share price would need to decrease to $76.03 before ITW's NPV MMA Differential increased to the $500 minimum that I look for in a stock with 51 years of consecutive dividend increases. At that price the stock would yield 2.4%.
Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $500 NPV MMA Differential, the calculated rate is 5.5%. This dividend growth rate is above below the 7.1% used in this analysis, thus providing no margin of safety. ITW has a risk rating of 1.75 which classifies it as a Low risk stock.
ITW has a history of generating above-average returns from growth in its end markets, along with a growth strategy focused on product innovation and acquisitions. The company is addressing its complex and fragmented business structure by shifting to more centralized operations which should increase efficiencies and lower costs, selling non-strategic operations such as its industrial packaging.
In late October, ITW reported earnings from continuing operations of $1.28 per share for third-quarter 2014, up 42% from the prior years $0.90 per share. The earnings improvement was primarily the result of 11.6% lower shares outstanding due to the company's share buyback program. For the year, ITW has raised its earnings guidance to $4.57−$4.65 per share from it previous guidance of $4.50−$4.62.
The company follows a consistent policy of returning value to its shareholders through dividends and share buybacks. In 2013, approximately $700 million was paid as dividends and $2.2 billion used for share buybacks. In mid-August 2014 the company announced a 15% increase to its dividend. In the first half of 2014, repurchased share totaling $2,905 million and paid dividends of $355 million.
ITW has a strong balance sheet with a debt to total capital of 48%, slightly above my preferred maximum of 45%. Its free cash flow payout is 35%, well below my 70% maximum. The stock is currently trading above my calculated fair value price of $67.46, its yield is well below the minimum I am willing to accept, so for now, I will wait on a more opportune time to add to my position.
Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.
Full Disclosure: At the time of this writing, I was long in ITW (2.7% of my Income Portfolio). See a list of all my dividend growth holdings here.
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