In many respects, Illinois Tool Works (NYSE:ITW) is both remarkable and bizarre. Illinois Tool Works is a serial acquirer, but instead of wasting shareholder money on executive vanity products, the company has a record of doing deals that seem to build value. What's more, the company operates in a lot of businesses that are widely considered to be commoditized, and yet the company maintains high market share, high margins and high returns on capital. In other words, Illinois Tool Works seems to defy a lot of the so-called rules about how big companies operate.

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The Quarter that Was
Like many other industrial conglomerates ranging from Dover (NYSE:DOV) to Danaher (NYSE:DHR), to United Technologies (NYSE:UTX), Illinois Tool Works has been enjoying a solid rebound in its overall business. For the company's fourth quarter, sales rose 11% as reported, with organic sales growth of better than 9%. Top-line growth was led by large segments like packaging and power systems/electronics, with organic growth in excess of 12% and 21%.

Although revenue growth is ticking along nicely, the profitability of the business is not doing quite as well by comparison. The company's operating margin did improve from the year-ago period (up to 13.9% from 12.7%), but the improvement was less than expected and the company did miss earnings (even with a lower-than-expected tax rate kicking in a few extra cents per share).

Nothing really stands out as an obvious source of disappointment, though, and the quarter is hardly a disaster. That said, the company did see a decline in gross margin and the ongoing price pressure in metals, energy, and other basic commodity inputs is not going to help matters.

The Look Ahead
ITW is involved in so many facets of the economy, it is almost unthinkable that there can be a recovery without the company benefiting. Recoveries mean that people buy more things; those things require the sort of packaging materials sold by Illinois Tool Works (and rivals like Owens Illinois (NYSE:OI)). (For more, see Analyzing Operating Margins.)

The same is true for segments like welding, food service, performance materials, coatings, and so on. Although Illinois Tool Works does have to contend with competition from the likes of Lincoln Electric (Nasdaq:LECO), Middleby (Nasdaq:MIDD), DuPont (NYSE:DD), Dover and many others, the company does not tend to linger in business where it is no longer competitive. Likewise, the company both incentivizes and enables managers across its 60 operating segments to do what it takes to stay competitive - leading to a relatively high level of new patent activity when compared to other U.S. industrials and conglomerates. (For more, see Dover Does Diversification.)

The Bottom Line
Tying the economic cycle to specific industries and companies is tricky, but Illinois Tool Works has the look and feel of more of a later-cycle play than many industrial conglomerates. That suggests, then, that the company's recovery may last longer than others who are already starting to face challenging comps.

Perhaps equally relevant, the company appears to be a quality undervalued name. There are relatively few fair comparables with higher returns on invested capital and yet the stock does not appear to trade at any real premium. Remember, this is a company that is still generating good margins from business like plastic strapping.

Assuming that the company can continue to produce a free cash flow margin in line with its 10-year historical average and grow revenue at an 8% clip for the next five years (faster in the early years, slower later on), the stock could be undervalued by 15% or more. That is very close to the point where a quality name like Illinois Tool Works becomes a compelling stock for value-oriented investors. (For more, see The Characteristics Of A Successful Company.)

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