Illinois Tool Works (ITW) Q4 2022 Earnings Call Transcript

Illinois Tool Works (ITW 0.72%)
Q4 2022 Earnings Call
Feb 02, 2023, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Cheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the ITW fourth-quarter earnings conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] For those participating in the Q&A , you will have an opportunity to ask one question and, if needed, one follow-up question. Thank you. Karen Fletcher, vice president of investor relations, you may begin your conference.

Karen Fletcher -- Vice President, Investor Relations

Thank you, Cheryl. Good morning and welcome to ITW's fourth-quarter 2022 conference call. I'm joined by our chairman and CEO, Scott Santi, and senior vice president and CFO, Michael Larsen. During today's call, we will discuss ITW's fourth-quarter and full-year 2022 financial results and provide guidance for full-year 2023.

Slide 2 is a reminder that this presentation contains forward-looking statements. We refer you to the company's 2021 Form 10-K and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations. This presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release. Please turn to Slide 3.

And it's now my pleasure to turn the call over to our chairman and CEO, Scott Santi.

Scott Santi -- Chairman and Chief Executive Officer

Thanks, Karen. And good morning, everyone. As you saw from our release this morning, in Q4, we delivered a strong finish to a year of high-quality execution in the face of some pretty unique challenges in the operating environment. Starting with the top-line organic growth.

It was 12% as all segments delivered positive organic growth, and five of our seven segments grew double digits led by auto OEM, up 20%; food equipment, up 17%; welding, up 15%; polymers and fluids, up 11%; and test and measurement and electronics, up 10%. Construction products was up 4%, and specialty products was up 3%. Operating margin expanded 210 basis points to 24.8%, with 110-basis-point contribution from enterprise initiatives and favorable price-cost margin impact of 70 basis points, which was, for the first time in nine quarters -- which was favorable for the first time in nine quarters. Incremental margin was 52%, and operating income grew 18%.

GAAP earnings per share increased 53% to a record $2.95. Including $0.61 of gains from divestitures and $0.12 of negative currency -- excluding $0.61, sorry, of divestiture gains and $0.12 of negative currency, EPS growth was 27%. For all of 2022, the company delivered organic growth of 12% for the second year in a row, a best-in-class operating margin of 24.4% in our base business, after-tax return on invested capital of 29.1%, and record GAAP EPS of 9.77, an increase of 15% versus the prior year. There's no question that our decision to stay invested in our enterprise strategy and in our people throughout the pandemic and the quality of our team's execution of our Win the Recovery focus coming out of it are powering the strong growth and financial performance ITW is currently delivering.

As a result, we are very pleased with our momentum and positioning heading into 2023. Turning to our 2023 guidance. Demand remains solid across the majority of our portfolio. And we are seeing meaningful improvements in supply chain performance and moderating input cost inflation.

At the same time, there's no question that the economic outlook, let's call it, remains certainly dynamic. As a result, our organic growth projection for 2023 of 3% to 5% and our EPS guidance of 9.60 at the midpoint reflect current levels of demand and a risk adjustment for further slowing in certain end markets. Michael will provide more detail on that in just a minute. Before I turn it over to Michael, I want to thank my ITW colleagues around the world for their extraordinary dedication and commitment to serving our customers and executing our strategy with excellence.

Michael, over to you.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Thank you, Scott, and good morning, everyone. The demand growth that we've experienced all year continued into the fourth quarter as revenue grew 8% with organic growth of 12%. On an equal-days basis, organic growth was 14% as the fourth quarter of this year had one less shipping day compared to prior year. We finished the year with strong growth momentum, as evidenced by our sequential organic revenue growth of +4% from Q3 into Q4 on a sales-per-day basis, as compared to our historical sequential of +2%.

By geography, every major region grew double digit with North America up 13%, Europe up 11% and China up 10%. Foreign currency translation headwind reduced revenue by 5%, and the net impact from acquisitions and divestitures was +1%. GAAP EPS grew 53% to 2.95 and included a $0.61 gain from two divestitures, which I'll provide more detail on in a moment. Excluding those gains, EPS increased 21% to $2.34, which included $0.12 of EPS headwind from foreign currency translation.

So, on an apples-to-apples basis, eliminating both divestiture gains and currency headwind, EPS increased 27%. On the bottom line, operating income grew 18% with strong incremental margin performance of 52%, and operating margin improved 210 basis points to 24.8%. Operating margin in our base businesses, excluding MTS, was 25.2%. In the fourth quarter, we achieved favorable price-cost margin impact of 70 basis points.

And as Scott said, this was the first quarter of favorable margin impact from price-costs since the third quarter of 2020. And our price initiatives contributed 110 basis points. As you saw in the press release, we completed two divestitures in the fourth quarter, resulting in a combined pre-tax gain on sale of $197 million recorded in nonoperating income, and an EPS impact of $0.61. By utilizing capital loss carryforwards to offset taxes on the divestiture gains, the overall tax rate for the company was 19.1%.

So, overall, for Q4, excellent operational execution across the board, strong financial performance in what remains a pretty uncertain and volatile environment. OK, please turn to Slide 4, starting with our progress on organic growth. And as you know, we've been aggressively executing a very focused growth strategy to build consistent above-market organic growth into a core ITW strength, on par with our operational 80/20 front-to-back capabilities. As you can see from the data on the left side of the slide, ITW's 12% organic growth rate for each of the last two years compares favorably to our proxy peers at about 9% both years, suggesting that while we're not there yet in terms of realizing ITW's full potential organic growth performance, we're making some very solid progress.

Moving on to the segments results, starting with automotive OEM, which led the way with organic growth of 20%. Year on year, revenue growth was, of course, helped by supply chain challenges in the industry last year. North America was up 15%, and Europe grew 23%. China was up 17% with particularly strong growth in electric vehicles.

On a full-year basis, ITW automotive OEM revenues were up 12% versus 6% growth in car builds. Looking forward, we expect automotive OEM to grow 5% to 7% in 2023 based on a risk-adjusted auto build assumption in the low single digits, plus our typical penetration gains of 2% to 3%. Turning to Slide 5. Food equipment delivered another very strong quarter with organic growth of 17%.

North America grew 25%, with double-digit growth in all major categories and end markets. Institutional was up more than 40%, with strength across the board. Restaurants were up 30%, and retail grew 20%. International revenue grew 7%, with Europe up 9%.

And Asia-Pacific was flat with some near-term softness in China. The food equipment team also delivered excellent progress on margins with Q4 operating margin of 27.6%, an increase of almost 500 basis points year over year. So, obviously, strong momentum in this segment. And we expect food equipment to grow 8% to 10% in 2023.

Test and measurement and electronics revenue grew 15% with organic growth of 10%. Test and measurement grew 12% organic, excluding the acquisition of MTS, with continued strong demand for capital equipment, as evidenced by Instron, which grew 24%. Electronics was up 7%. While our semi-related businesses, which represent combined annual revenues of about 550 million, or approximately 20% of the segment, grew 17% in the quarter, we are beginning to see a slowdown in demand after three years of very strong growth.

So, embedded in our 2023 organic growth projection of 2% to 4% for this segment is anticipated from the slowing in semi-related end markets. Moving on to Slide 6. Welding delivered strong organic growth of 15% in Q4, with equipment up 17% and consumables up 13%. Industrial sales remained very strong with organic growth of 25%.

On the commercial side, which is more consumer-oriented, demand continued to slow and organic growth was down 1%. On a geographic basis, North America grew 15%, and international grew 17%, driven by strength in the oil and gas business, up 19%. Operating margin was up 160 basis points to 31.6%, a new record for the segment and for the company. Looking forward, we expect revenue to grow 5% to 7% in 2023, which includes some anticipated further slowing on the commercial welding side.

Polymers and fluids delivered organic growth of 11%, with the automotive aftermarket business up 13% with some seasonal strength in wiper blades. Polymers grew 11% with continued strength in industrial applications, and fluids was up 5%. North America grew 11%, and international was up 10%. Looking forward, we expect polymers and fluids to grow 3% to 5% in 2023, which is based on current levels of demand and anticipated further slowing in the more consumer-oriented automotive aftermarket business.

Turning to Slide 7. Overall demand in construction slowed to an organic growth rate of +4%. North America was still up 9%, with residential up 11%, and commercial construction was down 6% due to a tough comparison of +21% last year. Europe was up 3% and Australia and New Zealand was down 4%.

As you know, construction is our most interest rate-sensitive segment, and we are projecting further slowing in 2023 and a negative organic growth rate of -5% to -3%. Specialty organic growth was 3% as supply chain shortages eased up in Q4. And the equipment businesses had a strong finish to the year with organic growth of 8%. Consumables were up 2%.

And on a geographic basis, North America grew 1% and international grew 7%. Looking forward, we expect specialty organic revenue of -1% to +1% in 2023, which is based on current levels of demand and anticipated further slowing in the appliance components business. So, let's turn to Slide 8 for a recap of a very strong 2022. As throughout the year, our teams around the world did an exceptional job of delivering for our customers by responding quickly and decisively to rapidly rising input costs, navigating supply chain disruptions, and aggressively executing our Win the Recovery strategy.

As a result, for the full year, ITW grew organic revenue by 12%, with double-digit growth in 5 of 7 segments. And despite significant price-cost margin pressures, and thanks in part to a 90 basis points contribution from our enterprise initiatives, our base businesses expanded operating margin by 30 basis points to 24.4%. GAAP EPS of 9.77 was a record for ITW, with EPS growth of 15% on top of 28% EPS growth in 2021. Excluding divestiture gains and negative currency translation impact, EPS grew 12% in 2022 on an apples-to-apples basis.

In 2022, we also invested more than $700 million to accelerate organic growth and to sustain productivity in our highly profitable core businesses; raised our dividend 7%, marking the 59th year of consecutive increases; returned 3.3 billion to shareholders in the form of dividends and share repurchases; and made solid progress on the integration of a very high-quality acquisition in the MTS test and simulation business. And most importantly, we delivered these results while continuing to make meaningful progress on our path to ITW's full potential through the execution of our long-term enterprise strategy. So, let's move to Slide 9 for an update on our full-year 2023 guidance. And while we certainly see some positives in terms of supply chains easing and moderating input cost inflation, there's also no doubt that the economic outlook and demand picture is becoming increasingly uncertain.

On our last Q3 earnings call, we pointed to pockets of slowing demand and approximately 20% of our business portfolio. And today, we would add semiconductor-related end markets to the mix, bringing the total to about 25% of ITW's portfolio. In our view, it, therefore, made sense to take a more cautious approach to our top-line guidance this year by basing it not just on current levels of demand adjusted for seasonality, as we typically do, but, rather, anticipating further slowing in end markets related to construction, commercial welding, auto aftermarket, appliances, and semiconductor. As a result, our organic growth rate projection for 2023 of 3% to 5% is lower than our typical run-rate approach.

Operating margin is expected to improve by 100 basis points or more to a range of 24.5% to 25.5%. This includes approximately 100 basis points contribution from enterprise initiatives and positive price-cost margin impact based on all known and implemented price and cost actions. After-tax return on invested capital should improve to 30% plus, and we expect strong free cash flow with conversion greater than net income. For 2023, we expect GAAP EPS in the range of 9.40 to 9.80, which also includes $0.15 to $0.20 of higher interest expense on our short-term debt and $0.25 of increased income tax expense as our tax rate will revert to our normal approximately 24% versus 22% in 2022 excluding the tax impacts from our divestitures.

In terms of cadence for the year, we're now back to our typical first-half-second-half EPS split of 49% and 51%. Our capital allocation plans for 2023 are consistent with our long-standing disciplined capital allocation framework. Our top priority remains internal investments to support our organic growth initiatives and sustain our highly profitable core businesses. The second priority is an attractive dividend that grows in line with earnings over time, which remains a critical component of IT's total shareholder return model.

Third, selective high-quality acquisitions such as MTS that enhance ITW's long-term profitable growth potential and have significant margin improvement potential from the application of our proprietary 82/20 front-to-back methodology and can generate acceptable risk-adjusted returns on our shareholders' capital. And finally, surplus capital will be allocated to an active share repurchase program. And we expect to buy back approximately $1.5 billion of our own shares in 2023. Turning to our last slide, Slide 10 for our 2023 organic growth projections by segment.

And you can see that we're expecting solid to mid -- solid mid to high single-digit organic growth in four of our seven segments, offsetting some lower growth rates in test and measurement and electronics, which is due to semiconductor demand, as well as in construction and specialty, resulting in an overall organic growth rate at the enterprise level of 3% to 5%, which is on top of 12% organic growth in each of the last two years. Overall, we're heading into 2023 with strong momentum, and we're very well positioned to continue to outperform in whatever economic conditions emerge as we move through 2023. So, with that, Karen, I'll turn it back to you.

Karen Fletcher -- Vice President, Investor Relations

OK. Thank you, Michael. Cheryl, please open up the lines for questions.

Questions & Answers:

Operator

[Operator instructions] We'll pause for a moment to compile the Q&A roster. Your first question is from Jamie Cook of Credit Suisse. Your line is open.

Jamie Cook -- Credit Suisse -- Analyst

Good morning and congrats on a nice quarter. You know, I guess my first question, you know, you talked about the 25% of your portfolio where, you know, you're starting to see weakness. Can you talk -- I know semi is the incremental. Can you just give a little more color on what you're seeing in semi? And then, on the 75% of the rest of your portfolio, are trends in line with your expectations a little more positive or negative versus last quarter? And then, I guess just my follow-up question to that, price-cost in the quarter, I think it was 70 bps positive.

I think that's a little better than what you expected. Was that driven more by price or raw going down? And then, what are your assumptions on the ability to hold price in 2023? Thank you.

Michael Larsen -- Senior Vice President and Chief Financial Officer

OK. That was a lot there, Jamie. I'll do my best, OK? So, I think that the color on semi is really the, you know, we're coming off a three-year very strong growth cycle with, you know, growth in the high teens or better than that over those three years. And we are starting to see a slowdown in the order intake really in Q4.

So, it hasn't really showed up in our numbers in a meaningful way yet, but we do expect that to continue into 2023. We think it's more of a near-term slowdown. And like you said, that is the addition to the portfolio, we've said before, 20% is slowing, demand is slowing, now it's 25%. And semi is really the incremental 5% this quarter.

But it's important to keep in mind that the balance, the other 75% of the portfolio, is -- continues to perform at a really high level. And I'll just point to the -- you know, the 12% organic we put up in Q4 and for the full year. And then, if you look at our guidance on Slide 10, you know, by segment, you can see mid to high single-digit growth in automotive OEM, food equipment, welding; mid-single digit in polymers and fluids; and then, a little bit lower in test and measurement. And then, of course, you know, construction is the one that's a little bit -- you know, projected to be down year over year, and specialty about flat.

I'll also say if you just look at, you know, from Q3 to Q4, we typically -- our sales per day go up, you know, 2%. We actually went up 4%. So, we're more than offsetting, you know, some of the slowing that we're seeing in 25% of the portfolio. So, good momentum, really well-positioned going into next year.

I think on the price-cost side, we were really encouraged. We talked about this on the last call and an expectation of being positive -- slightly positive on margins, on price-cost in Q4. This was a little bit better, driven by both sides of the equation, really price and cost, but it was certainly great to see that turn positive for the first time since I think I said the third quarter 2020, so the first time in eight quarters. So, really encouraging heading into 2023.

Jamie Cook -- Credit Suisse -- Analyst

Thank you.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Scott Davis of Melius Research. Your line is open.

Scott Davis -- Melius Research -- Analyst

Hey. Good morning, Scott, Michael, and Karen. Congrats on another strong year in '22.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Thank you.

Scott Santi -- Chairman and Chief Executive Officer

Thank you.

Scott Davis -- Melius Research -- Analyst

A little bit of a nit, but on the 3% to 5% '23 top-line -- or growth forecast, is there any real price in that, or you anniversary the big price increases that you had in welding, and now, you're kind of more in the kind of neutral-ish to maybe slightly positive versus a bigger number?

Michael Larsen -- Senior Vice President and Chief Financial Officer

Well, I think we are certainly lapping some bigger price numbers. There's no doubt about that. And I think, as you know, we don't break out price and volume separately for all the reasons we've talked about in the past. But there is a -- there's both price and volume in the numbers that we've laid out for 2023.

And the 3% to 5% organic, I'll just say, is a risk-adjusted number. If you do a pure run rate, you end up at a higher number. We just thought, given the -- everything we talked about, it was probably reasonable to take a more cautious approach given the environment.

Scott Davis -- Melius Research -- Analyst

Yeah. Now, totally makes sense. What about the inflation assumptions in general? When you guys think about the '23 outlook, as far as kind of breaking out materials versus labor, is it fair to assume that labor inflation remains reasonably high but material inflation is more moderated? Is that a fair assumption in your guide?

Michael Larsen -- Senior Vice President and Chief Financial Officer

Yeah, I think that's reasonable. I think, certainly, materials and components, in that order, you know, we are seeing -- I wouldn't say price are coming -- costs are coming down in a significant way, and they're remaining at a fairly elevated level. And I think on, you know, our labor costs, certainly, we're experiencing the same labor cost inflation as others. And about -- but -- and so, maybe a little bit higher than typical but nothing really that's significant.

You know, we're still expanding margins by 100 basis points or better here in 2023. So, hopefully, that answers your question.

Scott Davis -- Melius Research -- Analyst

Yeah, it does. Thank you. And best of luck this year.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Sure. Thank you, Scott.

Operator

Your next question comes from the line of Tami Zakaria of J.P. Morgan. Your line is open.

Tami Zakaria -- JPMorgan Chase and Company -- Analyst

Hi. Good morning. Congrats on the great results. So, I have a couple of quick ones.

The first one is, how should we think about your EBIT margin progression throughout the year? Is the 25.5 -- to 24.5 to 25.5 range going to be fairly consistent in all the quarters?

Michael Larsen -- Senior Vice President and Chief Financial Officer

So, Tammy, like I said, we're kind of back to our typical cadence here. I think we said, first half, 49% of our EPS for the full year. Second half, 51%. We really -- if you go back and look into time, we've been remarkably consistent.

Embedded in that is also the fact that Q1 is typically our lowest quarter in terms of revenue. And, you know, we're expecting somewhere in the mid-single-digit-type growth. Margins will probably start out a little bit lower but still 100 basis points of margin improvement on a year-over-year basis. And maybe just to give an additional data point, if you run the same data on Q1 contribution to EPS overall, it's somewhere around 23% of the full year.

And that's a pretty -- you know, the company has become remarkably predictable over the years. And so, I think that's probably a pretty good estimate for how the first quarter might play out.

Tami Zakaria -- JPMorgan Chase and Company -- Analyst

Got it. That's fantastic color. Thank you.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Sure.

Tami Zakaria -- JPMorgan Chase and Company -- Analyst

And I'm just going to ask the question and hope I get lucky and get a number. But can you share what organic growth is trending quarter to date? Any segments trending negative right now?

Michael Larsen -- Senior Vice President and Chief Financial Officer

So, we just saw the January numbers and everything looks fine. Everything is tracking and really nothing different from what we talked about in the script here. So, we're off to the start that we thought we would have.

Tami Zakaria -- JPMorgan Chase and Company -- Analyst

OK. Awesome. Thank you.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Sure. Thank you.

Operator

Your next question comes from the line of Andy Kaplowitz of Citigroup. Please, your line is open.

Andy Kaplowitz -- Citi -- Analyst

Hey. Good morning, everyone. 

Michael Larsen -- Senior Vice President and Chief Financial Officer

Hey, Andy.

Andy Kaplowitz -- Citi -- Analyst

Michael, when we think about margin expectations for '23 across your segments, does the lag in price versus cost flip the most in auto OEM, so, you could see a nice jump in margin in that segment? Or should we generally think that your segment margin will trend with who has the highest growth forecast versus the weakest growth forecast in '23?

Michael Larsen -- Senior Vice President and Chief Financial Officer

I think, Andy, we expect -- you know, all of our planning here at ITW is done bottoms up, as I think you know. And every one of our segments, including the higher-margin ones, such as welding, as well as automotive, which is really dealing with some near-term pressures primarily related to price-costs, as well as just volume leverage, every one of our seven segments told us that they expect to improve margins year over year in 2023. But obviously, the ones that have the higher growth rates are going to have more volume leverage and, therefore, probably a more significant improvement in operating margin. But everybody will get better.

I would just say, on automotive, you know, it's going to take some time to recover. The price-cost margin impact, which has been significantly higher in automotive than in other segments, for all the reasons we've talked about in the past, it takes a little bit longer to recover price. So, I think, you know, our current view is it'll take us, you know, maybe two to three years to get back to automotive margins in the low to mid-20s. And so, that's maybe how I would characterize it.

Andy Kaplowitz -- Citi -- Analyst

Very helpful, Michael. And then, can you give us an update on the longevity of enterprise initiatives? And ITW continues to be [Inaudible] at this point. I think we might begin to get a little spoiled here, you know, that it can last indefinitely. So, how are you thinking about enterprise strategy? Do you still see a long runway of initiatives across your segments? And where will the focus of enterprise strategy be across your segments in '23?

Michael Larsen -- Senior Vice President and Chief Financial Officer

Well --

Scott Santi -- Chairman and Chief Executive Officer

Yeah, go ahead. You start.

Michael Larsen -- Senior Vice President and Chief Financial Officer

OK. Well, I think we're in the 10th year now. I think if you add up the combined savings, it's approaching 1.5 billion of structural cost out from 80/20 and from strategic sourcing. And when we rolled up the plans here in November and checked back in January and had a chance to review all the projects and activities that go into delivering these 100 basis points, we were really encouraged by what we saw.

And so, I know that, for a couple of years, we've been saying, I've been saying, this is not going to go on forever. And I --

Scott Santi -- Chairman and Chief Executive Officer

Were wrong.

Michael Larsen -- Senior Vice President and Chief Financial Officer

And I was wrong, which happens a lot. But I think, ultimately, you know, look, I think if you model ITW long term, I'd go back to the TSR model we've given you, which is 4% plus organic growth, incremental margins in that 35% to 40% range; then, you know, operating income growth, 7%. You add acquisitions and buybacks on top of that, and so, EPS grows 9 to 10; and you add an attractive dividend in that 2 to 3 range -- 2% to 3% range. On top of that, you get 11% to 13% over the long term.

That's what you should expect us to deliver. And so, I think -- I hesitate to give you a definitive answer on enterprise initiatives because, as Scott reminded me, I've been wrong for many years, but that's probably how I would think about it, Andy.

Scott Santi -- Chairman and Chief Executive Officer

And I would just add, in terms of perspective, that I think one of the real strengths of our operating methodology and our business model is it's -- you know, there's no one definition of perfection. There is always room to get better. We use the business model as the core tool that our 84 divisions use to identify and prioritize opportunities to get better. And I don't see that stopping for quite a lot.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Right. I think we've said this before. I mean, this proprietary ITW business model is more powerful than it's ever been as we sit here today. It's much different from 10 years ago, three years ago.

And we are applying it. Our people have all gotten better at applying these methodologies. And we're applying it to a much more differentiated portfolio. And so, as long as we continue down that path, I think it is -- I agree with Scott, I don't think it's going to end any time soon.

So, that's probably how we'd set it up.

Andy Kaplowitz -- Citi -- Analyst

Appreciate all the color, guys.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Andrew Obin of Bank of America. Your line is open.

Unknown speaker

Hey, guys. You have Sabrina Abrams on for Andrew Obin. How are you?

Scott Santi -- Chairman and Chief Executive Officer

Good. How are you?

Unknown speaker

Good. So, first, on the margin guide, the 70 bps to 170 bps year-over-year expansion, you know, includes the 100 bps of enterprise initiatives. And then, I guess the remainder is 20 bps of price-cost at the midpoint. I'm just trying to think, is this a conservative approach? Should you add 70 bps of benefit in 4Q? Is there potential upside here?

Michael Larsen -- Senior Vice President and Chief Financial Officer

Well, I think maybe what would be helpful, Sabrina, is just let me just give you some of the elements here that go into the margin improvement on a year-over-year basis. And I'm going to use round numbers here, OK? So, if we just ended 2022 at operating margins of about 24%, you should expect volume leverage somewhere in the 50 to 100 basis points of positive contribution to margins year over year. The enterprise initiatives, which is sized at about 100. We're certainly going to make some good progress on, you know, price-cost.

The 70 basis points was encouraging in Q4. I think the -- if that's the run rate going into 2023, and maybe a little bit better than that, let's just say price-cost adds approximately 100 basis points based on what we know today. And then, the offset to some of -- this is our typical kind of -- we talked about this a little bit -- wages and inflation on wages. We are bringing in some new hires to support our organic growth efforts.

We are investing in driving organic growth, including capacity. And so, that's typically a headwind of less than, you know, 100 basis points. That's running a little bit higher, just given the underlying inflation that's in the system. That's probably running at 150 to 200.

And so, you add all that up, you get 100 basis points plus of margin improvement on a year-over-year basis. And I think that's a -- I think that's a pretty good number, Sabrina.

Unknown speaker

Got it. No, thank you. That's helpful. And so, China, I guess, was strong in auto OEM in 4Q.

Just trying to think what's incorporated in your guide for China reopening next year.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Well, I think, as we look at kind of on a geographic basis, including China, you know, most of our regions are kind of in that mid-single digits for the year. And China is maybe a little bit higher than that. A big driver, as you pointed out in China, is really the automotive business where we continue to, you know, make a lot of progress in terms of market share and penetration gains. So, that's certainly our largest business and also the biggest driver of our growth in China next year.

And so, if the total company is 3% to 5% organic, China is certainly a little bit higher than that in our current projections as we sit here today. So.

Unknown speaker

Great. Thank you so much. I'll pass it on.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Sure.

Operator

Your next question comes from the line of Jeff Sprague of Vertical Research. Please go ahead. Your line is open.

Jeff Sprague -- Vertical Research Partners -- Analyst

Thank you. Good morning, everyone.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Hey, Jeff.

Jeff Sprague -- Vertical Research Partners -- Analyst

Hey. Solid results. Just back to enterprise. You know, I've often kind of thought of it maybe incorrectly, you know, as -- you know, reflecting a little bit of a trade-off between margin and growth.

And maybe, originally, it was, you know, more cost-oriented. But, you know, the organic growth here recently would suggest, you know, you're not trading growth for margin. I wonder if you could just kind of comment on that. Obviously, the growth has enjoyed a cyclical lift the last couple of years.

I don't want to overstate the point, but it does seem that, you know, the system is throwing up better organic growth than it had historically. And if there's any context on that, I think would be interesting.

Scott Santi -- Chairman and Chief Executive Officer

Yeah. First of all, Jeff, thank you for noticing the -- you know, what I would say, in terms of just the arc of the last decade we've been on this is that, you know, clearly, for the first five to seven years, we had a lot more work to do inside the businesses to get ourselves in position to grow. And what we're delivering now is much more about businesses that are, you know, from an operational standpoint, a lot closer to 80% or 90% of their potential. And so, a lot of that -- which allows a lot of our effort and attention then just to be reallocated to the commercial opportunities to grow.

And that's ultimately what is showing up now. We have a lot more, you know, sort of energy collectively being devoted to growth opportunities because we've gotten the internal, you know, the operational positions of these businesses firing in sort of -- in really strong position. And so, it's -- you know, you can't be great at everything all at once. This is part of, I think, what we would reflect on over the last decade.

And one of the real secrets to the outcomes we've delivered, in my view, is that we've been focused on the right things at the right time and have not tried to do too much at any stage. But we're clearly now at a stage where organic growth is the 80 of, you know, what we've got opportunities to do and what we've got to deliver on going forward. And I think that's reflective -- reflected in the numbers that we're currently throwing off.

Jeff Sprague -- Vertical Research Partners -- Analyst

And would -- you know, Michael gave that piece of the bridge, you know, wage and growth investment, you know, is that number -- other than kind of the inflationary pressures that you mentioned, is that subtly moving higher? Or can that sort of be funded, you know, within the normal incremental margin construct than another level you've set before?

Scott Santi -- Chairman and Chief Executive Officer

Jeff, that's exactly the way we do it is we are -- you know, we are self-funding our growth investments through our incremental margin contribution. So, you know, the 35 historical and target run rate that is -- that includes -- that's after those incremental investments in growth. We are -- you know, we are investing in capacity now and in a really significant way, in headcount, in areas that help us grow and supporting innovation. And we're still going to deliver 100 bps of margin improvement next year.

So, that just illustrates the point that these businesses are so profitable that every incremental dollar of revenue that we generate organically drives a lot of incremental cash flow and certainly the support that we're going to invest some of that. But it doesn't impair our ability to bring a good chunk of it to the bottom line.

Jeff Sprague -- Vertical Research Partners -- Analyst

Great. Thanks for that context.

Operator

Your next question is from Stephen Volkmann of Jefferies. Your line is open.

Steve Volkmann -- Jefferies -- Analyst

Hey, good morning, guys. My question has been answered. A couple of quick follow-ups. Is there a portion of your portfolio where you would expect to give back price once the sort of lower energy and transportation and raw material costs kind of work their way through?

Michael Larsen -- Senior Vice President and Chief Financial Officer

We have a very small portion of our overall portfolio where the pricing is indexed to raw materials. If you add it all up, it's somewhere around 5% of our total revenue. So, really an immaterial number, where it's an automatic give back on price. I think, on everything else, you know, we historically command a premium given our -- the differentiated nature of our products and services and the quality of our delivery.

And we expect to maintain that premium as we compete and focus on gaining market share. So, that's how I would answer your question, Steve.

Steve Volkmann -- Jefferies -- Analyst

Great. Appreciate it. Pretty minimal then. And then, just sort of maybe the obligatory question on capital deployment relative to your thinking on any sort of further divestiture opportunities or M&A pipeline, anything to kind of call out there?

Michael Larsen -- Senior Vice President and Chief Financial Officer

Yes, I think you saw the two divestitures here in the fourth quarter. That's part of, you know -- I think we called out a handful of business units about a year ago. So, the first two are done. We've got a smaller one that's kind of been in the works.

And then, we've got a more meaningful one that is performing at a really high level right now. And I think we're going to kind of assess the capital markets and conditions and whether it's the right time to launch sometime this summer. And that would kind of round out what we talked about a year ago. So, that's kind of where we're at.

Steve Volkmann -- Jefferies -- Analyst

Great. And M&A pipeline, sorry.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Well, yeah, I mean, we get this question every time, we answer it the same way. I mean, I think organic growth is priority No. 1 for all the reasons that, you know, Scott just talked about. I think on the -- we've certainly be interested in high-quality acquisitions that accelerate the long-term growth potential of the company where we can know improve margins through the implementation of the business model and we can earn a reasonable rate of return on our shareholders' capital.

And so, MTS is a good example of an acquisition that checks all the boxes. That was a pretty big one that we did a year ago. And to the extent that other opportunities like that present themselves, that check the boxes, you know, we're definitely going to lean in and in a big way. So that's --

Scott Santi -- Chairman and Chief Executive Officer

Maybe just a little color on top of that that's more sort of topical near term. You know, what I would say generally is that, you know, we are not looking to acquire broken businesses. We're looking to acquire good businesses and help them be great businesses. And in environments where the sort of economic -- the macro is uncertain, those good businesses, those are really not a good time to sell.

So, if anything, I'd say that the environment, until the macro trajectory gets a little bit more clear, I -- you know, I would expect this -- that, you know, the opportunities might be a little less than normal this year, at least through the first half. But we'll see.

Steve Volkmann -- Jefferies -- Analyst

Good. Appreciate the color. Thank you.

Operator

Your next question comes from the line of John Joyner of BMO Capital Markets. Your line is open.

John Joyner -- BMO Capital Markets -- Analyst

Excellent. Thank you. So, the food equipment business, as you have highlighted, has definitely been a standout for you. And after attending the NAFEM food equipment show yesterday, I thought there was a notable difference in how the seg business seems to be presenting itself more cohesively than before.

So, will you comment on this aspect and also on some of the things that you're doing there with regard to consolidating sales reps and allocating more investments toward maybe the cooking side, specifically products like combi ovens and fryers, which are certainly areas that have well-known large competitors.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Well, I'll take a stab. I think we're not really doing anything different than we have over the last, you know, five years in the food equipment business. We have continued to invest in differentiated products, you know, including the categories that you mentioned. And we've been putting up --the team has been putting up some really great numbers as a result of executing on their strategy.

And so, if you add up the organic growth rate here, over -- you know, 17% coming out of the pandemic; 23% last year; this year, high single digit, double digit. And that's really as a result of us innovating and growing all product categories.

Scott Santi -- Chairman and Chief Executive Officer

Can I add to that? Near term, our supply capability is winning this business?

Michael Larsen -- Senior Vice President and Chief Financial Officer

Yeah, definitely, I think this has been an area we're kind of back to our Win the Recovery positioning. And the decision to carry enough inventory to service our customers, you know, with the same level of excellence in difficult supply chain conditions has paid off in a big way. And so, I think if you get the sense that the food equipment team is in a good mood, I think that's because they're gaining share and putting up some really strong numbers, including on the margin side. You know, if you look at that almost 400 -- it's almost 500 basis points of improvement on a year-over-year basis.

So, that business, like we said, is -- has got a ton of momentum going into 2023. And we're very bullish on the future year.

John Joyner -- BMO Capital Markets -- Analyst

OK. Thank you. Yes, they were definitely in a good mood. Thank you for the time.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Good, Good.

Operator

Your next question comes from the line of Joe O'Dea of Wells Fargo. Your line is open.

Joe O'Dea -- Wells Fargo Securities -- Analyst

Good morning. Thanks for taking my questions.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Sure. 

Joe O'Dea -- Wells Fargo Securities -- Analyst

I wanted to start at Slide 4 where you show the 300 bps of outgrowth versus the proxy group over the last couple of years. Can you talk to sort of attribution of that? I think, obviously, a pricing environment where we've seen different trends across different companies, we're not sure the degree to which maybe pricing is outpacing, but the degree to which it's volume -- you know, is it primarily share gain and just your confidence in the stickiness of those share gains as the supply chain corrects?

Scott Santi -- Chairman and Chief Executive Officer

Yeah, I guess my response would be that there's no way that we can break this apart into various pieces. What I can say is that the proof is in the pudding. Ultimately, it's in the performance, in our ability to consistently outperform. We're not claiming victory here.

We're not -- we're not -- we've got a lot of room to grow across the company in terms of our ability to consistently deliver the kind of organic growth that we're capable of. But, you know, what we are saying is we put a couple of years on the board where we are outgrowing our peers in the aggregate. And, you know, what percent of that is our market exposures versus theirs, or different approaches to pricing or supply capability, I'd say all of the above. In the end, it doesn't matter as long as we're able to consistently, you know, outgrow our peers and outgrow our markets.

And that's really the goal.

Joe O'Dea -- Wells Fargo Securities -- Analyst

And I guess related to that, as you're seeing maybe supply chain ease -- and I don't know if competitors are in the market in a little bit more competitive way -- but any challenges now that -- you know, that you didn't see, you know, maybe 6 or 12 months ago?

Michael Larsen -- Senior Vice President and Chief Financial Officer

Yeah, I think, Joe, from the beginning, the Win the Recovery positioning was all about strategic share gains focused primarily on our existing customers. And we were not interested in opportunistic onetime orders. And so, we're pretty confident with that direction, these share gains are going to stick. I think the pandemic and the supply chain kind of disruptions were a great opportunity for ITW to demonstrate how differentiated our supply chain capabilities are for those customers that didn't know.

And so, I think that's been really -- that's what's contributing, you know, also to the, you know, outgrowth relative to peers. I mean, that's one more element of the equation, as you talked about with Scott.

Joe O'Dea -- Wells Fargo Securities -- Analyst

And then, I just wanted to clarify, on the average daily sales, +2% versus seasonal -- or +4% versus seasonal +2%, the degree to which that's underlying demand accelerating versus maybe backlog burn -- I think it's hard to parse given, you know, broadly inflated backlogs out there, what underlying demand trends look like. But any comments on what you're seeing sort of underlying accelerate versus decel?

Michael Larsen -- Senior Vice President and Chief Financial Officer

Well, I think, you know, we're not a backlog-driven company. As you know, we don't carry a lot of backlog. And as you also say, it's hard to parse out what was backlog versus new orders. So, I'm not sure I can give you a great answer.

What I can tell you is that, you know, typically, our sales per day go up by 2%. If you go back and look in time, they went up by 4%. And so, things are definitely not slowing. And we've got some great momentum going into Q1 and 2023.

Joe O'Dea -- Wells Fargo Securities -- Analyst

Great. I appreciate the color.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Sure.

Operator

Your next question comes from the line of Julian Mitchell of Barclays. Your line is open.

Julian Mitchell -- Barclays -- Analyst

Hi. Good morning and thanks for squeezing me in. Maybe I just wanted to circle back to the organic sales growth guide and totally understand you don't take any elaborate, you know, macro gyrations within that, and that's a very sensible approach. But you've got the 4% growth guide for the year as a whole organically at the midpoint.

So, you just did low double digit the most recent quarter. So, just want to understand how we think about that sort of step-down. Is it a steady deceleration as we go through the year? Anything in particular we should bear in mind on, you know, one or two-year stacks? Any color at all really that you could give on how we think about the +4% moving through 2023?

Michael Larsen -- Senior Vice President and Chief Financial Officer

It's all in the comparisons year over year, Julian. So, like I said, we expect the year to play out, from a revenue standpoint, in line with our typical cadence. And so, Q1 starts out a little bit lower, and then, we kind of improve from there. But there's nothing baked in, in terms of a big acceleration in the back half or deceleration in the back half.

We've kind of done our best year to model current levels of demand risk adjusted for the areas where we're seeing some slowing in demand. And that we come up with 3% to 5%. I think if you run the math, you'll see kind of the first half is -- you know, the growth rates are maybe toward the higher end of that 3% to 5%, and the second half is toward the lower end. And that's all driven by the comps on a year-over-year basis.

Julian Mitchell -- Barclays -- Analyst

That's very clear. Thank you. And then, within construction products, I don't think we dealt with that one yet. Apologies if you have to repeat anything.

But, you know, that sort of down 4% guide for the year, there's a little bit of price in there. So, maybe volumes are down high single digit or something. But maybe just help us understand, you know, what's embedded within that. I think, simplistically, you have, you know, a third is really new build, a third is resi replacement, a third is commercial.

Those three big pieces, how are you sort of thinking about those this year?

Michael Larsen -- Senior Vice President and Chief Financial Officer

I mean, the big driver Julian, is the housing market --

Scott Santi -- Chairman and Chief Executive Officer

New.

Michael Larsen -- Senior Vice President and Chief Financial Officer

New housing. And so, the residential side is about 80% of our business here in North America. And that's where we're seeing some slowing, which we've talked about since the summer, I think. So, there's nothing new here.

And that's the big driver here.

Scott Santi -- Chairman and Chief Executive Officer

The commercial side is hanging in there. As I said, it was also our strongest business, you know, in the summer after the pandemic.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Right. Yeah. I mean --

Scott Santi -- Chairman and Chief Executive Officer

Part of the advantage of the different end market exposures we have is that we can -- you know, we're always going to have some in the tailwind mode and some in the headwind mode. But the net mix of it all is pretty positive. So, yeah, it's going to be down a little this year, but it's also been a business that's really performed well for us when other parts of the macro have been challenged, so.

Julian Mitchell -- Barclays -- Analyst

That makes sense. Thank you.

Michael Larsen -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Thank you for participating in today's conference call. All lines may disconnect at this time.

Duration: 0 minutes

Call participants:

Karen Fletcher -- Vice President, Investor Relations

Scott Santi -- Chairman and Chief Executive Officer

Michael Larsen -- Senior Vice President and Chief Financial Officer

Jamie Cook -- Credit Suisse -- Analyst

Scott Davis -- Melius Research -- Analyst

Tami Zakaria -- JPMorgan Chase and Company -- Analyst

Andy Kaplowitz -- Citi -- Analyst

Unknown speaker

Jeff Sprague -- Vertical Research Partners -- Analyst

Steve Volkmann -- Jefferies -- Analyst

John Joyner -- BMO Capital Markets -- Analyst

Joe O'Dea -- Wells Fargo Securities -- Analyst

Julian Mitchell -- Barclays -- Analyst

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