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Cannabis-Connected

This multi-industry manufacturing company thinks that one of its new products will be of special interest to cannabis sellers. This is just part of its strategic re-positioning into higher-profit-margin products.

Illinois Tool Works Inc., $150.50, symbol ITW on New York (Shares outstanding: 325.8 million; Market cap: $49.0 billion; www.itw.com), is a multi-industry manufacturing company operating in 55 countries. Known as ITW, it has roughly 48,000 employees.

The company’s diversified range of industrial products includes aerospace technology, bridges, wind turbines, restaurant appliances, packaging solutions, electronics, deep-sea welding products, and a range of automotive components such as fasteners, door handles, powertrain, and refueling systems.

ITW operates in seven industry segments: automotive products (23% of revenue), laboratory testing equipment (15%), food equipment (14%), consumer packaging & other specialty products (13%), welding equipment (12%), polymers & fluids (12%), and construction products (11%).

Through its Zip-Pak division, ITW makes a variety of re-sealable plastic bags for food or other products. The company recently unveiled a new slider, called Safety-Lok, which is difficult for young children to open. That would make it ideal to store medical and recreational cannabis. For now, however, ITW will avoid directly associating its packaging with cannabis until more jurisdictions legalize the drug.

In 2012, the company undertook a strategic re-positioning in which it aggressively exited businesses and product lines that were operating in what it saw as commoditized markets. ITW is now focused on markets and product lines in which profit margins can be sustainably maintained by quality and service differentiation. This strategic re-positioning also aims to implement a “decentralized, entrepreneurial culture that can flexibly respond to market demands.”

ITW’s revenue has remained relatively flat over the past five years as it divested itself of businesses and product lines. Revenue fell 7.4%, from $14.5 billion in 2014 to $13.4 billion in 2015. Revenue rebounded to $13.6 billion in 2016, and improved to $14.3 billion in 2017 and $14.8 billion in 2018.

As a result of focusing on higher-profit-margin products, earnings rose 35.6% over the same period, from $1.89 billion in 2014 to $2.56 billion in 2018. ITW has been steadily buying back its stock over the past five years. As a result, earnings per share jumped 62.7%, from $4.67 in 2014 to $7.60 in 2018.

Since the change in strategy, ITW has also raised its dividend by over 100%.

In the quarter ended March 31, 2019, revenue fell 5.1%, to $3.55 billion from $3.74 billion a year earlier. If you exclude businesses it sold, revenue declined 1.5%, mainly due to slowing demand from its automotive customers. Earnings per share fell 4.7%, to $1.81 from $1.90.

ITW’s balance sheet is sound: its long-term debt of $6.0 billion is just 12% of its market cap. It also holds cash of $1.76 billion.

The company faces rising raw material costs, partly due to the new U.S. tariffs on imports from China. As well, the high U.S. dollar hurts the contribution of its foreign operations, which supply roughly 55% of its total revenue. However, its restructuring and ongoing share buybacks should continue to pay off with higher per-share profits.

The stock currently trades at 19.0 times the company’s forecast 2019 earnings of $7.92 a share. ITW raised its quarterly dividend by 28.2% with the October 2018 payment, to $1.00 from $0.78. The shares yield 2.7%.

Illinois Tool Works is okay to hold.