Updated March 17th, 2021 by Bob Ciura
At Sure Dividend, we often talk about the merits of the Dividend Aristocrats. We believe that by and large this exclusive group of stocks has strong brands, consistent profits even during recessions, and lasting competitive advantage. These characteristics allow the Dividend Aristocrats to increase their dividends every year regardless of the economic climate.
Of the 500 stocks in the S&P 500 Index, only 65 are considered dividend aristocrats. You can download a copy of the full list of all 65 Dividend Aristocrats with metrics like dividend yields and P / E ratios by clicking the link below:
Every year we individually review all Dividend Aristocrats. Next in line is Illinois Tool Works (ITW). Illinois Tool Works has a long history of dividend growth even during recessions, which is particularly impressive given the cyclical nature of its business model. This article discusses the key factors behind Illinois Tool Works’ long history of dividends.
Illinois Tool Works has been in business for more than 100 years. It all started back in 1902 when a financier named Byron Smith placed an ad in The Economist. At the time, Smith wanted to invest in a “world class (manufacturing preferred) company in or near Chicago.” A group of inventors turned to Smith with the idea of improving the way they grind gears, and Illinois Tool Works was born.
Today Illinois Tool Works has a market capitalization of $ 56 billion and annual sales of nearly $ 15 billion. Illinois Tool Works consists of seven segments: Automotive, Food Equipment, Test & Measurement, Welding, Polymers & Fluids, Construction Products, and Specialty Products.
These segments have performed very well against their competitors and enabled Illinois Tool Works to achieve “Best of Breed” status in its industry.
Illinois Tool Works’ portfolio focuses on product segments that each have above-average growth potential in their respective markets. The overall strategic growth plan for Illinois Tool Works is to continuously transform the business model as necessary. The company often uses acquisitions to expand its reach.
At the same time, more than 30 divestments were made in raw material product lines with low growth. Illinois Tool Works routinely cuts companies off and adds new ones to maintain a growth path over time.
While 2020 was a very difficult year for the global economy due to the coronavirus pandemic that weighed heavily on economic growth, Illinois Tool Works continued to generate steady profits.
On February 5, 2021, Illinois Tool Works reported fourth quarter and full year 2020 results for the period ended December 31, 2020. Revenue for the fourth quarter was $ 3.48 billion, an increase of 0.2 % compared to the fourth quarter of 2019. Positive results in automotive, polymers and fluids, and construction products were offset by declines in food equipment, test and measurement, welding and specialty products.
Source: Investor Presentation
Net income for the fourth quarter was $ 642 million, or $ 2.02 per share, compared to $ 641 million, or $ 1.99 per share, for the fourth quarter of 2019.
For the year, Illinois Tool Works reported sales of $ 12.57 billion, down -10.9% from 2019. Net income was $ 2.11 billion, or $ 6.63 per share, compared to $ 2.52 billion, or $ 7.74 per share, in 2019.
Full year performance has been challenged by the mid-year coronavirus pandemic outbreak, but continuous improvement over the year bodes well for 2021 and beyond. Indeed, management expects a significant recovery in all areas of the company’s business.
Source: Investor Presentation
Illinois Tool Works also provided guidance for 2021, forecasting earnings per share between $ 7.60 and $ 8.00.
Overall, we expect annual EPS growth of 7% over the next five years, consisting mainly of sales growth and share buybacks.
Competitive advantage and recession performance
Illinois Tool Works has a significant competitive advantage. It has a broad economic “moat” referring to its ability to keep competition at bay. It does this with a massive portfolio of intellectual property. Illinois Tool Works holds over 17,000 issued and pending patents.
Another competitive advantage is the differentiated management strategy of Illinois Tool Works.
The company has applied a management process called “80/20”. This is an operating system that applies to all of Illinois Tool Works’ businesses. The company focuses on its biggest and best opportunities (the “80”) and seeks to eliminate costs or divest its less profitable activities (the “20”).
At the same time, Illinois Tool Works has a decentralized, entrepreneurial corporate culture. This also sets the company apart from the competition. Illinois Tool Works gives its various companies significant flexibility to customize their own approaches to best serve customers.
One possible disadvantage of the Illinois Tool Works business model is that it is prone to recessions. As an industrial manufacturer, Illinois Tool Works relies on a healthy global economy to grow.
Earnings per share during the Great Recession are shown below:
- 2007 earnings per share of $ 3.36
- 2008 earnings per share of $ 3.05, down 9%
- 2009 earnings per share of $ 1.93 (down 37%)
- 2010 earnings per share of $ 3.03 (up 57%)
Even so, the company remained highly profitable during the Great Recession. This enabled him to keep increasing his dividend every year during the recession, even if earnings declined. And thanks to its strong brand portfolio, the company recovered quickly. Earnings per share increased by 57% in 2010. By 2011, earnings per share exceeded the 2007 level.
A similar pattern was observed in 2020 when the coronavirus pandemic caused an economic recession. Illinois Tool Works’ earnings per share fell in 2020, but the decline was manageable and the company continued to raise its dividend.
Valuation and expected return
Using the current stock price of ~ $ 220 and the midpoint for earnings forecast of $ 7.80 for the year, Illinois Tool Works trades at a price to earnings ratio of 28.1. Given the cyclical nature of the company, we believe a price target of 18 is appropriate. This roughly corresponds to the company’s historical 10-year average.
As a result, Illinois Tool Works is currently overrated. Returning to our target value for money by 2026 would reduce the annual return by -8.5% over that period. Aside from changes in value for money, future returns will be determined by earnings growth and dividends.
We expect annual earnings growth of 7% for the next five years. Additionally, Illinois Tool Works stock has a current dividend yield of 2.1%.
The total return can include:
- 7% profit growth
- -8.5% multiple reversal
- 2.1% dividend yield
Illinois Tool Works is projected to return only 0.6% per annum through 2026. Very low forecast returns result in a sell recommendation for Illinois Tool Works, though the company’s ability to raise dividends through multiple recessions is impressive. The company has now seen dividend growth for 46 straight years after increasing its dividend by 6.5% in August 2020.
Illinois Tool Works is a good quality company and an even better dividend growth stock. It has a strategic growth plan that is working well, and shareholders have been rewarded with increasing dividends for over 40 years.
The stock also boasts a decent dividend yield of 2.1%, which could make it an attractive choice for investors with long-term dividend growth. Stocks aren’t attractively valued right now, and it is likely that the company will struggle if a recession hits.
Illinois Tool Works is a classic example of a great company, but it’s not a stock to buy right now. Despite its status as a dividend aristocrat, we encourage investors to wait for a better entry point before buying shares in Illinois Tool Works.
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