2023-03-07 12:50:49 ET
Summary
- ITT's Motion Technologies business is a global leader in brake pads, shock absorbers and sealing solutions for the automotive and rail markets.
- The Industrial Process business segment of ITT is a global leader in centrifugal and twin-screw pumps for the chemical, energy, industrial and mining markets.
- The Connect & Control business provides differentiated and highly engineered products to markets that are more than $20 billion in size and it has leadership position in mission-critical components.
- In the long term, ITT targets a long-term revenue CAGR of 5% to 7%, adjusted segment operating margin of 20%, adjusted EPS growth CAGR of 10% and free cash flow margin between 11% to 13%.
- The company has a very strong balance sheet, with more than enough dry powder for management to spend on capital expenditures, generate returns for shareholders through share repurchases and dividends.
Investment thesis
I find that the opportunity with ITT ( ITT ) is rather unique, in my view, as it is an unassuming industrial company without much hype. I shared with members of Outperforming the Market that ITT as a company has solid business fundamentals and, in my view, is a long-term compounder. In this article, I will explain why I think that ITT is a long-term compounder that you need in your portfolio. The company has been able to achieve market leading positions in several aspects in its business. Its execution towards margin expansion and EPS growth has been rather stellar in my view and the long-term financial targets look achievable. Furthermore, the company's business continues to ride on secular tailwinds like electrification, energy transition, rebound in commercial aerospace, amongst others. On top of that, I like that ITT has a very strong balance sheet and it has more than enough resources to reinvest in its business, carry out acquisitions and at the same time, generate returns for shareholders in the form of share buybacks and dividends.
An overview of ITT
As illustrated very nicely below, ITT's business is made up of three main business segments. Motion Technologies make up 50% of revenue while Industrial Process and Connect & Control Technologies make up 30% and 20% respectively. In terms of end markets, the automotive market contributes a large part of ITT's revenue. Lastly, on geographies, North America and Europe take up the majority of the business, with a combined 75% of revenue.
Business segments, end markets and geographies of ITT (ITT IR)
Going deeper into each business segment, a significant portion of the Motion Technologies business segment comes from Automotive, while Rail makes up most of the other revenue from the segment. For the Industrial Process business segment, this is largely dominated by the three end markets of General Industrial, Chemical and Energy. Lastly, for the Connect & Control Technologies business segment, the three end markets that make up the majority of revenue are General Industrial, Defense and Aerospace.
ITT individual business segments (ITT IR)
Motion Technologies
ITT is a global leader in brake pads, shock absorbers and sealing solutions for the automotive and rail markets.
The business segment is made up of brands like GALT smart pad which has strong innovations like integrating data into the world of braking, KONI which revolutionized the suspension industry, Wolverine Advanced Materials which is a leading developer and manufacturer of high-performance materials. Other brands include Novitek Fine Blanking , Axtone.
Today, the current mix of electric vehicles is around 21%, which includes 16% in hybrid and 5% in electric vehicles.
In its friction business, ITT is a leading global brake pad supplier and has outperformed global vehicle production by about 800 basis points annually on average. More importantly, it has content in most of the leading electric vehicle OEMs. In 2021, ITT had 33 electric vehicle platform awards, and more than 70 in the past three years.
In terms of outlook by end markets for the Motion Technologies segment, management expects long-term growth in the double-digit range as a result of low inventories in North America and Europe, limited rebound opportunity due to supply chain disruptions and semiconductor shortages.
ITT end market outlook (ITT IR)
I like that management illustrates a great example of an award win with leading electric vehicle companies through its award with Tesla ( TSLA ). The initial award for Tesla was for its Model S and X in North America. As a result of the consistency and top quality of the Motion Technologies platform, management expects that awarded volumes will grow from 315,000 pads in 2021 to 4.9 million pads in 2025.
In terms of innovation going forward, ITT aims to establish industry leadership for green and safe brake pads. This means that today, it is investing towards using eco and recycled materials, incorporating new materials to generate a new green and sustainable portfolio and reduced carbon footprint.
ITT is leading in innovation for intelligent brake pads for intelligent cars. This is a new type of brake pad that is able to seamlessly integrate with the sensing system and there will be sensors and proprietary algorithms that measure performance and safety-related characteristics in real time. This new innovation will be aligned to the future autonomous vehicle trends of the future and meet the requirements of electric vehicles today. At the end of the day, this type of leading innovation will ensure better safety, higher performance and lower environmental impact.
In terms of long-term financial targets for the Motion Technologies segment, management expects revenue CAGR of 6% to 7% in the long term and adjusted segment margin to expand by 80 basis points to 20% in the long-term. The driver for revenue will come from an acceleration in penetration in electric vehicles, continued outperformance in OEM and potential accretive M&A.
Industrial Process
The Industrial Process business segment of ITT is a global leader in centrifugal and twin-screw pumps for the chemical, energy, industrial and mining markets. Centrifugal pumps make up almost 80% of the business.
Some of the brands in this business include Goulds pumps , which focuses on mining, oil and gas and power generation markets, Bornemann , Engineered Valves ., and the recently acquired Habonim .
The Industrial Process segment has leading market positions in North America as a result of its customer centric mindset and unique distribution network. The business continues to be executed well and continued to improve on its offerings. About 20% of the portfolio is upgraded through efficiency and design-to-cost initiative and the business looks to develop energy transition market opportunities. These energy transition market opportunities were bolstered by the recent acquisition of Habonim, which has cryogenic and hydrogen ball valves offerings for green energy applications.
There are many blue-chip customers in the Industrial Process business, as can be seen below.
ITT blue chip customers (ITT IR)
In terms of the financial targets for the Industrial Process business segment, management expects long-term revenue CAGR of 5% to 7% and a long-term segment margin of 20%, implying 450 basis points improvement over time.
Connect & Control Technologies
The Connect & Control Technologies business segment is a niche player in the harsh environment connectors and control components in critical applications. The main market is serves is the general industrial market, which makes up 46% of revenue. Brands in the business include cannon , BIW connector systems , Aerospace Controls , Veam and Enidine .
The business provides differentiated and highly engineered products to markets that are more than $20 billion in size and it has leadership position in mission-critical components.
The following figure will help visualize some of the products and offerings of the business. A large majority of the business comes from connectors as it has strong brands that are leaders in their fields.
Product of CCT (ITT IR)
Furthermore, the Connect & Control Technologies ("CCT") business ride several secular trends like the rebound in commercial aerospace, increase in global defense spend and the increasing electrification and industrial digitalization.
Lastly, the company continues to invest to improve its offering and expand its portfolio to meet customer requirements and gain market share.
The CCT business has been in the electric vehicle charging connector market since 2010 and they expect the business to grow at a rapid CAGR of 20% until 2025. This is one of other growth drivers like the rebound in commercial aerospace, increasing investment and upgrade in defense systems, warehousing automation systems, amongst others.
ITT growth drivers for CCT (ITT IR)
For the CCT business, management expects the revenue to grow at 9% to 11% CAGR over the long-term, while segment margin will grow by 680 basis points to 22% in the long-term
Financials
I like that in the 5-year period from 2017 to 2021, the company has expanded margins significantly despite a modest revenue growth. In the 5-year period, adjusted operating margins expanded by almost 400 basis points and free cash flow margin expanded by almost 500 basis points. In addition, adjusted EPS outpaced revenue growth significantly, growing 56% during the period.
ITT historical 5-year financial performance (ITT IR)
As illustrated below, management expects that its balance sheet will be very strong in the next three years. With $2.6 billion to $3.4 billion in dry powder, there is more than enough for management to spend on capital expenditures, generate returns for shareholders through share repurchases and dividends.
The focus for ITT will be to carry out acquisitions and invest organically, but the surplus will allow ITT to generate strong returns through share repurchases and grow dividends in-line with earnings growth.
3-year cash availability suggests strong firepower (ITT IR)
In the long-term, ITT targets a long-term revenue CAGR of 5% to 7%, adjusted segment operating margin of 20%, adjusted EPS growth CAGR of 10% and free cash flow margin between 11% to 13%
Valuation
My one-year price target for ITT is $102. This implies 10% upside from current levels. I am initiating ITT with a Buy rating despite the relative lower upside potential. I think that a better entry would be more desirable, and the Buy rating is based on the compelling narrative of the company's long-term compounding of profits and cash flows over time and the leading competitive position of the business. On top of that, the company continues to ride secular industry tailwinds, as highlighted above, providing it a long runway for growth.
Risks
Supply chain risks
In the near-term, there are risks that ITT might face disruptions in the supply chain or continued persistent inflation in raw materials. Although ITT has been able to fare well so far and show its ability in managing these risks, the business continues to face these risks in the near-term.
Risk of execution
With a large balance sheet and dry powder for more acquisitions, there is a risk that ITT might have execution issues with its acquisitions. While I think that management has been doing a good job with acquiring companies that grow topline and earnings over time, there is also the risk of execution and overpayment.
Conclusion
All in all, I think that ITT is well positioned as a company to achieve its long-term financial targets. The company has multiple secular tailwinds to ride in the form of the energy transition, acceleration in electric vehicle adoption, increase in defense budgets, amongst others. ITT has market leading positions in many markets it operates in and continues to make innovation a priority for its business as management continues to spend on organic investments and capital expenditures to grow the business.
I think that the current management is focused on expanding margins and generating accelerating EPS growth and improving free cash flow margins. At the same time, as the balance sheet grows stronger, ITT has more dry powder to reinvest in the business, carry out acquisitions or generate shareholder value through share buybacks or dividends.
At the end of the day, I like ITT as an unassuming industrial company with a management focused on generating strong EPS growth and margin expansion with a long-term compounding opportunity.
For further details see:
ITT: Long-Term Linear Compounder In The Making