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REAL CLIENT MANAGED PORTFOLIO MEMORANDUM
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Real Client Managed Portfolio Spring 2013 Class
Kaushik Andra, Dan Ballantine, & Keaton J. Cervantes
Illinois Tool Works Inc. Investment Recommendation
April 23, 2013
RECOMMENDATION: WATCH LIST
Macroeconomic and Industry Overview
Overall, we see the United States becoming more competitive internationally in the future
due to the weakening of the dollar. Further, rising labor costs in foreign countries make the
United States more attractive, where labor costs have been high in the past, but are not growing
as quick as foreign countries. Within the United States, there is a trend of increased labor in the
right-to-work states, which are predominantly located in the South. The industrial goods
industry is capital intensive and highly competitive due to the variety of industry players in
addition to the lack of a dominant company.
Company Overview
Illinois Tool Works Inc. (NYSE: ITW) is a diversified manufacturer of industrial
products and equipment headquartered in Glenview, Illinois. ITW’s primary business segments
include transportation, power systems & electronics, industrial packaging, food equipment,
construction products, polymers & fluids, and other products. In the future, ITW hopes to derive
80% of its revenues from 20% of its product line by divesting a significant amount of its current
operating segments.
Valuation
Comparable Companies Approach
We used seven comparable companies to value Illinois Tool Works including Cummins
Inc. (CMI), Danaher Corp. (DHR), Ingersoll-Rand Plc. (IR), and Stanley Black & Decker
(SWK). We analyzed the forward P/E, forward TEV/EBITDA, forward TEV/Sales, and
Price/Book Value ratios to determine an implied value of ITW. We excluded the Price/Book
Value ratio in our final valuation because four comparable companies did not have a meaningful
data point. Our comparable company analysis led to an implied value of $56.76 per share.
Discounted Cash Flow Analysis
We projected ITW’s financial statements over the next five years to determine its
enterprise value based on future free cash flows to the entire company. For the discount rate, we
used the weighted average cost of capital, which was 13.51%. We incorporated the realized
annual returns of ITW shareholders over the past four calendar years into our cost of equity,
along with a CAPM-based estimate. We arrived at an estimate of $46.33 per share for ITW’s
share price based on our DCF Analysis.
Recommendation
Overall, we recommend that Illinois Tool Works remain on the RCMP Watch List.
While we liked the company’s geographically diversified revenue base and improved operating
margins, our concerns about ITW’s future outweighed the positives. Our primary concern is
management’s ability execute the restructuring plan to divest operating segments. We believe
ITW could be worth another review in 18-36 months after the company has gone through its
restructuring phase.