Tickers in this Article: ITW, DOV, GE, DHR, HON
You never can quite tell what the market will value on one day or the next. For much of this reporting cycle growth has been all that investors have cared about, but the market seems to be making an exception for Illinois Tool Works (NYSE:ITW). Although management came in short of growth targets for the first quarter and lowered guidance for the rest of the year, investors seem to think the better margin results are fair compensation.

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Weak Equipment Defines Q1
Like so many other industrial names that have reported so far, including companies like Dover (NYSE:DOV), General Electric (NYSE:GE), and Honeywell (NYSE:HON), Illinois Tool Works is caught in the teeth of a pretty severe slowdown in industrial demand.

Reported revenue declined 8%, but the decline was limited to about 3% on an organic basis. Europe remains a major area of weakness (down almost 6% this quarter), and equipment sales were likewise quite weak (down 6% against a 1% decline in consumables). By unit, automotive was surprisingly strong (up 4% organic), while polymers/fluids, industrial packaging, and welding were notably weak.

As mentioned, Illinois Tool Works did alright on margins. Gross margin not only rose a point from last year and more than half a point from the prior quarter, but exceeded sell-side expectations. While some of this could be mix (including less equipment in favor of consumables), margin improvement has been a targeted management goal with policies like more centralized sourcing. Operating income was down about 5% as reported, but actually improved about 1% on an adjusted basis.

SEE: Understanding The Income Statement

Interesting Comps For This Quarter
Looking at the results from ITW and its rivals, this was an odd quarter. There's certainly ample evidence that the overall global industrial environment is weak, but there's also ample evidence that good exposure to certain markets (China up more than 10%) or particular product launch cycles/share gains can lead to better results.

In the case of the automotive business, for instance, Illinois Tool Works did noticeably better than Honeywell (NYSE:HON) and Johnson Controls (NYSE:JCI). What's more, the company's business was only down 2% in Europe, despite a sizable decline in regional build volumes (between 8% and 10% depending on the source).

On the other hand, the company's performance in welding lagged that of Lincoln Electric (Nasdaq:LECO) and not by a trivial amount. Likewise, the company seemed to do worse than Danaher (NYSE:DHR) in test and measurement and worse than Dover in food equipment. Industrial packaging and construction both seemed a bit weak as well, though it's worth remembering that the ITW has already announced its intention to get out of the packaging business and that its North American construction performance wasn't really inferior to what companies like RPM (NYSE:RPM) have seen.

The V-Shaped Recovery Looks A Little More U-Like
With ITW missing the revenue target this quarter, I suppose it shouldn't be that unexpected that management would lower its target a bit for the year. What's more, the immediate reaction in the market would seem to suggest that investors aren't begrudging the revision, nor abandoning their hope that the second half of this year is going to see a big recovery in industrial demand. We've heard this story again and again from multiple companies, which could argue both for its credibility and the risk to the market if it fails to arrive.

In the case of Illinois Tool Works, though, I'd be wary of a couple points. First, this company has more exposure to Europe than most of its peers like Honeywell, Danaher, and GE. Second, margins have been volatile here lately, and the company's ongoing restructuring efforts could add to that in the short term.

The Bottom Line
Illinois Tool Works is a well-run company, and with its broad economic cycle exposure I can understand how and why investors would look to own this for many years at a time. Moreover, I see nothing wrong with management's progress on margin improvements, nor its recent acquisition/divestment decisions (other than to suggest they may be done … I don't believe ITW will ever be entirely finished shuffling its deck).

SEE: Analyzing An Acquisition Announcement

The only real issue with ITW is that it rarely ever gets all that cheap. If the company can post about 3.5% long-term revenue growth and roughly double that growth rate for free cash flow, the shares trade right about where they ought to today. That may mean investors should at least kick the tires on names like Dover or GE, but Illinois Tool Works isn't a bad hold here today unless you fear a major market washout over the next few months.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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