Updated on March 17th, 2021 by Bob Ciura
At Sure Dividend, we often talk about the merits of the Dividend Aristocrats. We believe this exclusive group of stocks broadly have strong brands, consistent profits even during recessions, and durable competitive advantages. These qualities allow the Dividend Aristocrats to raise their dividends every year, regardless of the state of the economy.
Of the 500 stocks comprising the S&P 500 Index, just 65 qualify as Dividend Aristocrats. You can download a copy of the full list of all 65 Dividend Aristocrats, complete with metrics like dividend yields and P/E ratios, by clicking on the link below:
Each year, we individually review all the Dividend Aristocrats. The next in the series is Illinois Tool Works (ITW). Illinois Tool Works has a long history of dividend growth even through recessions, which is especially impressive given the cyclical nature of its business model. This article will discuss the major factors for Illinois Tool Works’ long dividend history.
Illinois Tool Works has been in business for more than 100 years. It started out all the way back in 1902, when a financier named Byron Smith placed an ad in the Economist. At the time, Smith was looking to invest in a “high class business (manufacturing preferred) in or near Chicago.” A group of inventors approached Smith with an idea to improve gear grinding, and Illinois Tool Works was born.
Today, Illinois Tool Works has a market capitalization of $56 billion, and generates annual revenue of nearly $15 billion. Illinois Tool Works is composed of seven segments: Automotive, Food Equipment, Test & Measurement, Welding, Polymers & Fluids, Construction Products and Specialty Products.
These segments have performed very well against its peers, and has allowed Illinois Tool Works to achieve “best of breed” status in its industry.
Illinois Tool Works’ portfolio is concentrated in product segments that each hold above-average growth potential in their respective markets. The overarching strategic growth plan for Illinois Tool Works is to continuously reshape its business model, when necessary. The company frequently utilizes bolt-on acquisitions to expand its reach.
At the same time, it has conducted more than 30 divestments in commoditized, low-growth product lines. Illinois Tool Works routinely trims businesses and adds new ones, to maintain a growth trajectory over time.
While 2020 was a very difficult year for the global economy, due to the coronavirus pandemic which weighed heavily on economic growth, Illinois Tool Works continued to generate steady profits.
On February 5th, 2021 Illinois Tool Works reported Q4 and full year 2020 results for the period ending December 31st, 2020. For the fourth quarter, revenue came in $3.48 billion, which was up 0.2% compared to Q4 2019. Positive results in Automotive, Polymers & Fluids and Construction Products was offset by declines in Food Equipment, Test & Measurement, Welding and Specialty Products.
Source: Investor Presentation
Fourth-quarter net income equaled $642 million or $2.02 per share, compared to $641 million or $1.99 per share in Q4 2019.
For the year, Illinois Tool Works reported revenue of $12.57 billion, a decline of -10.9% compared to 2019. Net income equaled $2.11 billion or $6.63 per share compared to $2.52 billion or $7.74 per share in 2019.
The full year performance was challenged by the onset of the coronavirus pandemic in the middle portion of the year, but continued improvement throughout the year bodes well for 2021 and beyond. Indeed, management expects a significant recovery across the company’s business segments.
Source: Investor Presentation
Illinois Tool Works also provided 2021 guidance, anticipating earnings-per-share between $7.60 and $8.00.
Overall, we expect 7% annual EPS growth over the next five years, comprised mainly of revenue growth and share buybacks.
Competitive Advantages & Recession Performance
Illinois Tool Works has a significant competitive advantage. It possesses a wide economic “moat”, which refers to its ability to keep competition at bay. It does this with a massive intellectual property portfolio. Illinois Tool Works holds over 17,000 granted and pending patents.
Separately, another competitive advantage is Illinois Tool Works’ differentiated management strategy.
The company has employed a management process called “80/20”. This is an operating system that is applied to every business line at Illinois Tool Works. The company focuses on its largest and best opportunities (the “80”), and seeks to eliminate costs or divest its less profitable operations (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 empowers its various businesses with significant flexibility, to customize their own approaches to serving customers in the best way possible.
One potential downside of Illinois Tool Works’ business model, is that it is vulnerable to recessions. As an industrial manufacturer, Illinois Tool Works is reliant on a healthy global economy for growth.
Earnings-per-share performance during the Great Recession is below:
- 2007 earnings-per-share of $3.36
- 2008 earnings-per-share of $3.05 (9% decline)
- 2009 earnings-per-share of $1.93 (37% decline)
- 2010 earnings-per-share of $3.03 (57% increase)
That said, the company remained highly profitable during the Great Recession. This allowed it to continue increasing its dividend each year during the recession, even when earnings declined. And, thanks to its strong brand portfolio, the company recovered quickly. Earnings-per-share soared 57% in 2010. By 2011, earnings-per-share surpassed 2007 levels.
A similar pattern was seen in 2020 as the coronavirus pandemic caused an economic recession. Illinois Tool Works’ earnings-per-share declined in 2020, but the decline was manageable and the company continued to raise its dividend.
Valuation & Expected Returns
Using the current share price of ~$220 and the midpoint for earnings guidance of $7.80 for the year, Illinois Tool Works trades for a price-to-earnings ratio of 28.1. Given the company’s cyclical nature, we feel that a target price-to-earnings ratio of 18 is appropriate. This is roughly in line with the company’s 10-year historical average.
As a result, Illinois Tool Works is currently overvalued. Returning to our target price-to-earnings ratio by 2026 would reduce annual returns by -8.5% over this period of time. Aside from changes in the price-to-earnings multiple, future returns will be driven by earnings growth and dividends.
We expect 7% annual earnings growth over the next five years. In addition, Illinois Tool Works stock has a current dividend yield of 2.1%.
Total returns could consist of the following:
- 7% earnings growth
- -8.5% multiple reversion
- 2.1% dividend yield
Illinois Tool Works is expected to return just 0.6% per year through 2026. Very low projected returns results in a sell recommendation on Illinois Tool Works, though the company’s ability to raise dividends through multiple recessions is impressive. The company now has 46 consecutive years of dividend growth after increasing its dividend by 6.5% in August 2020.
Illinois Tool Works is a high-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 rising dividends for over 40 years.
The stock also has a decent 2.1% dividend yield, which could make it an appealing choice for long-term dividend growth investors. Shares are not attractively priced at the moment, and it is likely the company will struggle if and when a recession occurs.
Illinois Tool Works is a classic example of a great company, but not a stock to buy right now. Despite its status as a Dividend Aristocrat, we suggest investors wait for a better entry point prior before purchasing shares of Illinois Tool Works.