Between the company's December analyst day and the general market melt-up, shares of Illinois Tool Works (NYSE:ITW) made a fresh 52-week high on Jan. 28. Management used that analyst day to highlight some logical steps toward better growth, margins and returns for the long term, but these fourth quarter results serve as a reminder that self-improvement programs don't usually follow smooth lines. Illinois Tool Works has long been a solid generator of free cash flow and returns on capital, but investors may want to pause before chasing this stock further.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

Not so Impressive in the Fourth Quarter
Illinois Tool Works didn't have a terrible fourth quarter, but it was a reminder that the company's restructuring program is going to have some ups and downs. Moreover, several of Illinois Tool Works' units offer up reminders that for all of the post-election optimism, conditions are still challenging.

Excluding divestitures, revenue rose 2% as reported, good for a slight beat versus Wall Street, but organic revenue growth was only 0.6%. Only two segments had positive organic growth - Transportation (up about 4%) and Construction (up about 1%). Power Systems (which is now where welding and electronics reside), Industrial Packaging and Food Equipment were all down about 1%, while Polymers/Fluids saw organic revenue decline 7%.

I don't expect investors to be all that bothered by the revenue numbers (though the rare decline in welding was a surprise, and should make the Lincoln Electric (Nasdaq:LECO) numbers more interesting), but the margin numbers were disappointing. Gross margin rose a bit from last year, but fell more than a point sequentially.

Operating income was down 6%, and the company not only showed a 60 basis points (BPS) decline in operating margin from last year, but a 250 BPS drop from the prior quarter. There wasn't all that much correlation between revenue and margin performance by segment - Industrial Packaging and Polymers both reported double-digit operating income growth, while Construction was down by 14%.

SEE: How To Decode A Company's Earnings Reports

Finding Growth Could Be More Challenging in 2013
Admittedly, none of the major industrial conglomerates like General Electric (NYSE:GE), Danaher (NYSE:DHR), 3M (NYSE:MMM) or Dover (NYSE:DOV) have pointed to stellar growth expectations for 2013. Even so, Illinois Tool Works falls on the weaker end of guidance with an expected organic growth of 1 to 3%.

The company did well in its auto business (up 11%) this quarter, certainly better than others like Johnson Controls (NYSE:JCI) or Honeywell (NYSE:HON), but that will be tough to maintain absent a recovery in vehicle production activity. Likewise, while the company saw good growth in North American construction, there still hasn't been a real turn in residential or commercial activity.

Against that backdrop, I wouldn't be surprised to see more quarter-to-quarter turbulence in the operating figures. Restructuring programs are lumpy by nature, and moves like streamlining and centralizing purchasing could create a little extra variability.

The Long-Term Plan Is Legit
Partly in response to pressure from investors, Illinois Tool Works has laid out a five-year plan for the first time. In addition to the previously announced moves to re-centralize and consolidate purchasing, management has re-categorized its operating businesses into above-average, average and below-average growth buckets. About 25% of the company's current revenue fits in the below-average profile, and could be put up for sale in the coming years. At the same time, management is looking to do fewer deals, but is making them larger and more impactful.

SEE: Evaluating A Company's Management

Focusing in on better growth prospects is good news for investors, particularly as the company has only shown about a 1% organic growth over the past 10 years. It will be interesting, though, to see how the divestment process impacts margins and cash flow - just because a business isn't growing well doesn't mean it's not a lucrative margin or cash-flow generator.

The Bottom Line
I've often complained about Illinois Tool Works' valuation, and today is no exception. Simply put, for the growth and economic returns on capital available here, I think Wall Street is paying too much. Companies like Danaher and 3M aren't particularly cheap, either, but you're arguably getting better businesses there, particularly from an organic growth perspective. To the extent that owning any of these stocks is a requirement, I'd go with GE, 3M or Danaher before Illinois Tool Works at today's respective prices.

At the time of writing, Stephen D. Simpson owned shares of 3M for over five years.

Related Articles
  1. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  2. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  3. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
  4. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  5. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  6. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  7. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  10. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!