Is The Rally Over For Illinois Tool Works?

ITW: Illinois Tool Works logo
ITW
Illinois Tool Works

With over a 58% rise since the March 23 lows of this year, at the current price of around $186 per share we believe Illinois Tool Works stock (NYSE:ITW) has reached its near term potential. ITW stock has rallied from $118 to $186 off the recent bottom compared to the S&P which moved 47%, with the resumption of economic activities as lockdowns are gradually lifted. ITW stock is also up 53% from levels seen in early 2019.

ITW stock has fully reached the level it was at before the drop in February due to the coronavirus outbreak becoming a pandemic. This seems to make it fully valued as, in reality, demand and revenues will likely be lower this year than last year.

Most of this rise over the last year or so was primarily led by P/E multiple expansion. Looking at fundamentals, the company’s revenues were down 4.5% y-o-y in 2019, while its Net Margins improved by a modest 3% from 17.4% to 17.9%. This clubbed with a 3% reduction in total shares resulted in EPS growth of just 1.7%.

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While the company has seen modest margins and earnings growth over recent years, its P/E multiple has seen a significant increase. We believe the stock is unlikely to see significant upside after the recent rally and the potential weakness from a recession driven by the Covid outbreak. Our dashboard, ‘What Factors Drove 53% Change in Illinois Tool Works Stock between 2017 and now?‘, has the underlying numbers.

Illinois Tool Works’ P/E multiple increased from 16x in 2018 to 24x in 2019. While the company’s P/E is now 24x there is a downside when the current P/E is compared to levels seen in the past years, P/E of 16x at the end of 2018 and 23x as recently as late 2019.

So what’s the likely trigger and can the stock stick to recent gains?

The global spread of coronavirus has meant lockdowns in various cities, and increased restrictions on the movement of people. With industrial plants working at a limited capacity, the overall demand for Illinois Tool Works products, including fasteners, and adhesives among others, has declined. In fact, the company’s Q2 revenues were down 29%, led by the Automotive OEM segment, which saw its revenue plunge 54% to $361 million. Illinois Tool Works manufactures components and fasteners for automotive-related application, and the automotive sector in particular has been among the worst hit sectors during the current pandemic. Given these trends, the company’s full year revenue will likely see a 17% decline in sales, and 27% decline in its earnings per share, based on average consensus estimates.

However, the situation on the ground is changing now, with economies gradually opening up, and industrial output picking up after seeing a decline in March and April. Over the coming weeks, we expect continued improvement in demand and growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view, with investors focusing their attention on 2021 results. As such, the recent gains in the stock may stick, but any significant upside from the current price is unlikely in our view. Though market sentiment can be fickle, and evidence of a sustained uptick in new cases could spook investors once again. 

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