Illinois Tool Works Easily Beats Guidance

Diversified industrial specialist Illinois Tool Works (ITW +0.00%) did it again: The company's first-quarter results breezed past guidance, and management raised full-year expectations. It continues to outperform its end markets and expand operating margin. In addition, its segments most affected by the industrial weakness in the U.S. in 2016 are now starting to turn. There's a lot to look at, so let's dive into the details.

Illinois Tool Works first-quarter results: The raw numbers

Starting with the headline numbers from the quarter:

• GAAP EPS of $1.54 came in significantly ahead of the guidance range of $1.39 to $1.49.
• Organic revenue growth of 3.5% exceeded guidance of 1% to 2%.
• Operating margin of 23.3% compared to guidance of 22.5%-plus.

Clearly a strong set of results, and they gave cause for management to raise or maintain full-year 2017 guidance:

• GAAP EPS guidance range of $6.20 to $6.40 compared to a previous range of $6.00 to $6.20.
• Organic revenue is now expected to grow 2% to 4% compared to a previous range of 1.5% to 3.5%.
• Operating margin guidance maintained at 23.5%-plus.

The guidance for the second quarter is for GAAP EPS of $1.55 to $1.65 with organic revenue growth of 2% to 4%. In other words, the rate of growth in the second quarter is the same as that forecast for the full year, implying that management believes its current rate of growth is sustainable.

What happened in the quarter

Pretty much everything went right for Illinois Tool Works in the first quarter. A few of the highlights include:

• The most cyclically weak segments in 2016 -- test and measurement and electronics and welding -- look like they are picking up (as seen in the chart below).
• Illinois Tool Works continues to outperform its key end markets, with the automotive original equipment manufacturer (OEM) segment organic growth higher than the growth of automotive industry builds in North America, Europe, and China.
• Overall operating margin growth of 120 basis points (where 100 basis points is 1 percentage point) includes a 100-basis-point contribution from volume compared to a 30-basis-point contribution from volume in the fourth quarter of 2016, indicating that strengthening end markets are leading to margin expansion.
• The key automotive OEM segment -- around 24% of segment income in the quarter -- generated organic growth of 9% despite fears of auto production plateauing in 2017.
• The construction segment's organic growth of 3% is a strong result considering that organic sales for Illinois Tool Works in North America declined 2%, largely due to facing a very tough comparison of 11% growth in the first quarter of 2016.

A quick look at quarterly year-over-year organic revenue growth confirms the pickup in welding and test and measurement and electronics. Indeed, another company with heavy exposure to welding, Lincoln Electric Holdings, Inc., reported a 5.5% sales increase in its first quarter, with CEO Chris Mapes speaking of "end markets, which were trending steady to up in the first quarter, with only portions of energy and shipbuilding remaining globally challenged" on the earnings call.

Data source: Illinois Tool Works presentations. Chart by author

Looking ahead

It's hard to know what more investors could expect from management right now. End markets appear to be improving, and Illinois Tool Works continues to generate above-average growth and margin expansion through a combination of management's so-called enterprise initiatives (which aren't solely reliant on end market conditions) and volume growth. Aside from continued growth in its end markets, one thing investors could look out for is rising cost pressure -- what management terms as "price/cost" shaved 30 basis points off operating margin in the quarter compared to 10 basis points in the previous quarter.

Otherwise, it was a strong quarter and investors continue to be rewarded by Illinois Tool Works.