Illinois Tool Works Inc. (ITW) Earnings Call Transcript & Summary

Perfect. So thank you, everyone, for joining. My name is Julian Mitchell, and it's my pleasure to have now Illinois Tool Works and Michael Larsen, CFO, for our fireside chat this morning. Just as a reminder, if you have any questions, please e-mail them to me, and I'll make sure to try and ask them. And also, if you get a second, please do try and fill out those survey questions at the side of the screen. And so with that, I'll hand over to Michael quickly before we go into the Q&A.

Thank you, Julian. Thank you for having us, and good morning, everybody. We thought we'd just kind of try to set the stage a little bit upfront, and then, of course, we can go into the Q&A. But if we just take a brief look back on 2020, I think as we were managing through the pandemic, I think what became very clear that the progress that we've made in terms of executing our long-term enterprise strategy over the last 8 years really put ITW in a position of significant strength in dealing with the pandemic, and that strength was really built on this really powerful ITW business model. We've talked many times about ITW as a business model-centric company. I'm sure we'll come back to that. But -- and particularly -- particularly, our 80/20 front-to-back operating process and our decentralized entrepreneurial culture served us extremely well during this period of uncertainty and rapid change. Obviously, our best-in-class margin profile going into the year with margins around mid-20s. EBIT margin was a big advantage for us, the fact that we have a high-quality, highly diversified business portfolio. If you look at our segments, 7 segments, all segments have margins in the mid-to-high 20s at this point. There was never any balance sheet risk going into the pandemic. ITW has a strong balance sheet, Tier 1 credit ratings, and we generate a lot of free cash flow conversion rate significantly above 100% on a regular basis. So we leverage this position of strength. And I think as a team and particularly our operating teams executed really well on the things within our own control to deliver some pretty strong financial performance given the environment. Our operating income ended up close to $3 billion, operating margins for the year of 22.9%. The low point, by the way, in the second quarter was 17.5%, and we did 25% in the fourth quarter. So really resilient margin performance. Strong free cash flow of $2.6 billion, as you would expect, from ITW. And I think in terms of return to shareholders, the -- we raised the dividend by 7% in August. So at this point, we are -- continue to aggressively execute our long-term strategy. We're focused on winning the recovery. We can talk about what that means, and really continue to deliver differentiated performance over the long-term. And maybe just to reiterate for the people that may not be that familiar with ITW, again, this is -- the ITW business model is our competitive advantage. And our strategy is centered around leveraging this business model to its full potential and deliver solid growth with best-in-class margins and return. We're really trying to position this company to deliver top-tier performance across a wide range of economic scenarios over a 5-year period. So that's really what this company is geared towards. And our goal, ultimately, is to firmly establish ITW as one of the highest quality, best-performing industrial companies out there. So hopefully, that kind of helps set the stage a little bit, Julian, and then I'll let you take it from here.

Yes, sure. Thank you, Michael. So I suppose definitely, the business model had a severe sort of battle test in 2020, came through it with flying colors. When you think now about the recovery, particularly you mentioned that sort of winning the recovery aspect. Maybe help us flesh out sort of what does that mean for ITW? What are perhaps some of the segments where we might see that? Market share gain is one manifestation of it. Where could we see that the fruits of that market share push be perhaps more evident than some of the others?

Yes. Well, I think in terms of winning the recovery, we have to go back to kind of the priorities during the pandemic. So at the height of the pandemic, we really focused the entire company essentially on 2 things. One was protect the health and well-being of our colleagues around the world, which meant that we provided full compensation and benefits in the second quarter, during the worst of it. We did not initiate any COVID-specific restructuring. We were able to stay invested in our people, in our projects, our long-term strategies, our new products. We did not cut back on those. We didn't cut back on pay and benefits. The second priority was really continue to serve our customers with excellence. And so our customers were going through some challenging times. If you look at our customer base back in the second quarter, we had segments where our customers were essentially shut down for most of the second quarter followed by a very rapid recovery, by the way, starting in Q3 and continued into Q4. And so our ability to continue to serve those customers in terms of quality, delivery, service, we believe, is a real differentiator, not just in a few specific divisions but really across the company our ability to do that. And so those 2 things, we believe, have really helped position the company to fully participate in the recovery phase. And we are -- we're looking for sustainable, strategic share gains at ITW-caliber margins. So these are not opportunistic, let's take this order and just to boost sales. This is all consistent with our long-term enterprise strategy of delivering solid, above-market organic growth with best-in-class margins and returns. I don't have a hard and fast number. I can give you in terms of what are those share gains worth in 2021. I think given the recovery, it's really hard to establish numbers around market growth versus ITW growth. And so we'll have to wait a little bit with that, but lots of evidence inside the company where every division can cite specific examples of where they were able to support their customers. As a result of that, we have gained additional market share to really support the Win the Recovery strategy as we go forward.

And I think a couple of years ago, ITW had talked about adding a point or 2 to enterprise sort of organic sales growth as part of the finishing of the job concept. How do you feel the progress has been on that? Obviously, there's the complications of a big downturn. But as you look at the recovery ahead now, does that 1% to 2% outgrowth number or extra organic growth numbers seem optimistic, conservative? Are things sort of lining up to support it?

I think, Julian, it's very achievable. We -- given the differentiated nature of our businesses, given the focus we've had on organic growth as the primary growth engine really since the launch of the enterprise strategy back in 2012 and then the specific focus on organic growth and strategic excellence, including incentive plans designed around that starting in 2016, we were actually making good progress in '17, in '18. In '19, we quantified that as we believe we were growing 1 percentage point above the kind of the markets inside of ITW. And our goal is to get to 2 to 3 percentage points of outgrowth relative to the underlying market. We are doing that already in a number of divisions and segments. So we know how to do it. It's just a matter of maintaining our focus. And I think, again, back to what we're just talking about, the fact that we were able to stay invested in our commercial strategies, in our people, for -- in sales and marketing and new products during the pandemic, I think, is really going to serve us well as we move forward. Like I said, in 2020, 2021, it's hard to tell what the underlying market growth is. Maybe with the exception of -- you'll know what auto production is, auto builds at the end of the year and so we can look at ITW's relative growth rate. I think we put out a 16% growth number, for example, in auto OEM, and builds are expected to be somewhere around 14%. So you are seeing that outgrowth relative to the underlying markets. And so to answer your question, I think all of us here are laser-focused on organic growth. And we have a high degree of confidence that we will get there in terms of being able to, on a consistent basis, outgrow the underlying markets by 2 to 3 percentage points.

Perfect. And perhaps you've given the guidance for 2021 f enterprise-wide and by segment. I suppose on that point, you have a big surge in the first half of easy comps and perhaps some slowdown in the second half just on a comp basis. But what are the businesses that you think in that second half can keep driving good organic growth when you're looking at the different segments? And perhaps when you look beyond this year, you've seen some cycles at ITW, you've seen cycles at your previous roles, how do you assess the slope or shape of what this industrial upturn could look like beyond just the next 9 months?

Well, so, Julian, as you know, we're not economists here. And -- we are owner operators of these high-quality businesses. And our guidance is based on what we're seeing in these businesses today. So we're -- as you know, I just -- maybe everybody is not that familiar, but we're assuming that current levels of demand stay the way they are inside of our business and we're projecting those, call them, run rates into 2021 adjusted for seasonality. And you do that, you get to an organic growth rate in that 7% to 10% range, obviously, significantly higher in the second quarter. The bulk of the decline in 2020, somewhere around 2/3 of it, was in the second quarter. And so obviously, the comps are a lot easier in Q1 and Q2. But we expect to continue to grow in -- throughout the year. And so the question really is one of -- where do you expect that markets will accelerate or slow down? And again, we're not really economists. There are people that make a living trying to project those things. We -- given the short-cycle nature of our businesses, we are a company that really read and -- can read and react to the order trends like in our business units as we see them today. So there's no incentive for us to go out on a limb and try to project what this recovery might look like. What I can tell you is, obviously, if you look at the fourth quarter, all of our businesses made progress in Q4 relative to Q3 and certainly Q2. I think in terms of acceleration, we saw the -- sequentially, revenues were up 5% from Q3 to Q4, where normally, they're essentially flat. So really good progress, not just in Automotive but also in some of the more CapEx-related businesses. So I think in Welding, we saw a nice pickup on the -- not just on the commercial side but also on the industrial, kind of the heavy equipment side of things. And as we talked about on the earnings call a few weeks ago, that momentum really carried into 2021, and January is off to a solid start here. And so we are -- based on what we're seeing in our businesses, obviously, our guidance reflects that, high single-digit organic growth, earnings, EPS growth in the high teens at the midpoint. So I think we're reasonably -- we're confident and optimistic going into 2021.

Perfect. And you mentioned on the whole, ITW clearly performed extremely well in the last 12 months. Those businesses that had been viewed as perhaps growth challenged pre-COVID. Maybe help us understand how some of those have performed. And I sort of ask that in the context of the statement that divestments will be left for 2022 to allow some of the weaker stuff right now to sort of have its cyclical lift?

Yes. Well, so the growth-challenged businesses, it's a very small number. I mean, we're talking about a handful of businesses with combined revenues of somewhere -- it's in $100 million, hundreds of millions of dollars, not billions. These businesses are, in their respective industries, best-in-class businesses. They are -- certainly from -- in terms of margins and returns and just the quality of how these businesses are run, they're better than most of their competitors. They just don't have the level of differentiation that they need to get to ITW-caliber organic growth rates and margins and returns. And so in terms of kind of the long-term strategic fit, our views have not changed since -- when we talk about divestitures in 2018, we still believe that these are a better fit with other companies. I'd say 2 things. This year, Julian, we're focused on winning the recovery. And all of our focus -- the best thing we can do for our -- for the company is to get the organic growth rate going. And so that's our primary focus is on the recovery, take care of our people, take care of customers, get the organic growth rate going. And divestitures are a little bit of -- are a distraction. And I think given how they're performing this year and as M&A markets kind of normalize, we actually, by the way, think they're going to be worth more money in 2022. So we're just going to defer it for now and really focus on them on accelerating the enterprise strategy and get to our full potential. And then ultimately, we will get to the divestitures at some point here.

One point, I suppose, circling back to the share gain and the winning the recovery, several industrial companies, they've talked about stepping up investments this year with that view to -- well, look, revenue growth is good. It will stay good for a while. So let's invest a lot now to ensure we maximize our market share in that revenue rebound. And that's obviously having some negative impact on margins, at least in 2021. When you look at ITW in the context of sort of that message, it doesn't sound like there'll be that need for stepped-up investment. Maybe just give us some context around your perspectives on that. CapEx may have to come up. But other than that, it sounds like other things are at a good run rate already.