ITW - Illinois Tool Works: Great Company But Not A Value Investment At Current Prices

2023-09-17 03:51:38 ET

Summary

• Illinois Tool Works is a company that has consistently increased its dividend payout for over 25 years.
• The company has shown slow but steady revenue and income growth over the past decade.
• Share buybacks have helped increase earnings per share and reduce the dividend expense for shareholders.

Income investments make up a large portion of my portfolio. Dividends provide a positive feedback loop that show my money is working for me. Hopefully, I'll eventually have enough money working for me that I won't have to work for money any more. That day will be a few years down the road, however.

I am always looking into companies that might make a good investment that will hopefully provide a growing income stream over a period of decades. That income should hit my account every quarter (or month), and if revenue and earnings grow, the amount of income will grow as well.

One company that looks interesting from an income perspective is Illinois Tool Works ( ITW ). This company has increased its dividend payout for more than a quarter century, placing it within a relatively small group of investments that has shown an ability to grow its dividend in a range of investing conditions.

ITW Financials

To support a growing dividend, it's important for companies to hopefully grow revenue. However, it's even more important to grow cash flow and income. The latter is where ITW has shone over the past decade.

Illinois Tool Works is a company that has seven business segments, which range from automotive parts to construction products to food equipment that major companies use on a daily basis throughout the economy. The company attempts to address the specific needs of its customers, and this strategy led to the filing of 1,700 new patents in 2022 .

Over the past decade, the company's revenue has grown by about $1.8 billion to $15.932 billion. This is not a rapid increase, but the company has been in business since 1912 , which makes it a very mature company. As companies get larger and older, they tend to have a slower growth rate. Nevertheless, ITW estimates revenue of between $16.3 and $16.6 billion in 2023. The most recent quarterly report showed a 3% organic revenue growth over the same quarter in 2022. Operating income reached $1 billion for the first time in the second quarter of 2023. The company appears to have a slowly growing revenue stream.

Over the past decade, net income has nearly doubled, going from $1.669 billion to $3.034 billion, which indicates greater efficiency, as the company's revenue has grown nowhere near a similar rate. The earnings per share has grown at an ever greater clip, more than doubling (and nearly trebling) from $3.74 per share $9.77 per share since the 2013 annual report.

Share buybacks have helped this latter number greatly. The company has bought back nearly one-third of its shares in just the past 10 years. Additionally, the company just announced an additional $5 billion in share buybacks in early August. This will drop the number of shares outstanding even more.

Share buybacks are beneficial in a couple of ways. First they increase the percentage of the company owned by shareholders who stick around. Therefore, each share is worth a greater ownership percentage, and the remaining shareholders have a greater claim on earnings. Additionally, when the number of shares decreases, it helps lower the amount paid for dividends. The dividend expense on 307 million shares would be less than it would be for 446 million shares if the amount paid out per share stayed the same. (The share count numbers are those outstanding for ITW in 2022 and 2013, respectively.)

Companies can get into trouble when they use debt to finance share buybacks. This is probably going to become less likely with higher interest rates, but many companies borrowed a massive amount of money in recent years to buy back shares. However, it does not appear that ITW has utilized this strategy extensively. Long-term debt more than doubled from 2013 to 2014 to $5.943 billion, yet it sat at just $6.173 billion with the 2022 annual report. Indeed, the company has paid off nearly $2.6 billion in long-term debt since 2019, which greatly improves its financial positioning for the long run.

Dividends

For income-focused investors like me, the dividend a company can pay is an important factor in deciding to make an investment. Older companies that are seemingly boring can become much more interesting when they pay a growing dividend.

ITW has a dividend of $1.40 per quarter. This was an increase of $0.09 per share from the previous payout, an increase of nearly 7% . Over the past five years, the company has increased its payout by 10.93% on average. This would see the dividend double approximately every seven years or so. The dividend has grown for 27 consecutive years, which shows a strong commitment to returning value for shareholders. Additionally, it's frequently said that the safest dividend is the one that's just been raised. The current payout ratio is around 55.57%, according to Seeking Alpha's dividend page for Illinois Tool Works. Therefore, there is room to continue growing the dividend.

The yield for ITW is not the greatest. It currently sits at 2.34%, and it has generally been between 2% and 2.5% over the past ten years, with a few exceptions on either side of that range, most notably for a few days around the COVID-19 crash in 2020, when the yield exceeded 3%. With a solid record of dividend growth, however, an investor could invest today and see a strong yield on cost in future years.

Current Value

Most of the numbers associated with ITW make it attractive, with the exception of cost. Those who have held the company for years will appreciate the price growth the company has exhibited. It's up more than 22% over the past 12 months, despite trading at about 12% off its recent highs. The company's share price has more than trebled over the past ten years to its current price of $238.31 per share as of September 15, 2023. Those who have reinvested dividends would see an even greater return as their share count increased while the number of shares outstanding dropped rapidly due to share buybacks.

The company's current PE ratio seems a bit high at 25.23 as of September 13 . Although this is not a record for the company, a few years ago, this number was in the 8-12 range for a fairly lengthy period of time (most of the 2010-2015 period). A higher PE ratio makes continued share appreciation difficult, so this is an important consideration for those who might want to invest going forward.

Conclusion

ITW appears a bit overpriced at current levels, the recent drop notwithstanding. However, the company does have a shareholder friendly policy of greatly reducing its share count (without taking on an excessive amount of debt to do so) while also increasing its dividend at a healthy level. Income-focused investors might find the company an interesting investment. Those who bought years ago have obviously done quite well. Those looking to get in today to see some price appreciation might find future returns a bit anemic, as it appears that revenue growth is quite slow. Illinois Tool Works is definitely a hold, but I am not likely to purchase unless there is a fairly significant pullback in the price. Even though this is a great company, I would like to see a better purchase price.

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