Tickers in this Article: ITW, BWA, ETN, JCI, LECO, DOV, MIDD
A quick look at the earnings of industrial conglomerate Illinois Tool Works (NYSE:ITW) really does bring out just how broad the economic recovery is right now. What's more, with an appealing mix of early/mid/late cycle businesses and a relatively undemanding valuation, there may yet be an opportunity for investors to use this name as a general play on the improving economy.

TUTORIAL: How To Analyze Earnings

Not Many Flaws in the First Quarter
There is not much that jumps out as problematic about the first quarter at Illinois Tool Works. Revenue rose more than 17% as reported and nearly 12% on an organic basis. Growth was led by diverse segments like packaging, transport and welding, while even the "laggards" showed reasonable growth - food equipment grew more than 6% on an organic basis and the construction business grew more than 8% despite no real discernible improvement in building activity. (For more, see Conglomerates: Cash Cows Or Corporate Chaos?)

Looking at the profits, the company clearly saw some pressure from rising input costs, but it was not insurmountable. The company held the line on gross margin while growing operating income by 26%. Not only did the company beat the average estimate, but it also exceeded its own guidance (though that is not all that unusual for this company, as it tends to be conservative with guidance).

Plenty of metrics looked good this time around, and the return on capital continues to increase. What passes for negative news might be the free cash flow production this quarter (though quarter-to-quarter free cash flow is meaningless) and the pace of acquisitions. Illinois Tool Works did six deals worth about $556 million and brought in $329 million in acquired revenue, suggesting that deals are getting more expensive (the company acquired $530 million in revenue through 24 deals costing $531 million in 2010).

Checking the Look-Throughs
Illinois Tool Works is certainly benefiting from being in some of the right markets right now. Auto and truck production has rebounded strongly, and Illinois Tool Works is seeing some of the same strong performance that investors are seeing in names like BorgWarner (NYSE:BWA), Eaton (NYSE:ETN), Cummins (NYSE:CMI) and Johnson Controls (NYSE: JCI). Likewise, Illinois Tool Works' strong growth in welding (up 23%) is showing up in rivals like Lincoln Electric (Nasdaq:LECO) as well.

With the relative underperformance of Illinois Tool Works in the food equipment sector, it will be interesting to see what sort of performance Middleby (Nasdaq:MIDD) can deliver. Dover's (NYSE:DOV) results seemed as though they might have been stronger, but it's not a straight apples-to-apples comparison and Dover does not break out its food equipment sales in much detail. Still the question is worth asking - is Illinois Tool Works losing out to a more aggressive up-and-comer, or is the restaurant and food industry still reticent to invest in equipment? (For more, see Is Dover Worth The Trouble?)

The Bottom Line
ITW is a good one-stop shop for investors seeking broad exposure to several industrial markets, and the company's performance is certainly strong right now. It is also worth mentioning that the company could likely do even better - while ITW has solid returns on capital, the company's free cash flow conversion is a bit low relative to some other conglomerates (like Dover and Danaher (NYSE:DHR) for instance). If management can find the means to squeeze even more free cash flow out its revenue base, it would be a great source of upside to investors.

As it stands, Illinois Tool Works is undervalued and still worth a look even if the company can find only modest expansion in free cash flow margin. Just an extra half-percent though, over five years, would be worth another $3 in fair value, so this is a metric well worth watching. In the meantime, while the double-digit economic recovery won't last forever, there still seems to be a chance to make money from these shares. (For more, see Conglomerates: Risky Propostion?)

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