What happened

Shares in multi-industry industrial Illinois Tool Works (ITW -0.95%) fell 11.3% in September, according to data provided by S&P Global Market Intelligence. The move reflects the likelihood of pressure on ITW's profit margin from rising raw material prices and mounting supply chain issues in the economy.

Companies as diverse as FedEx, PPG Industries (supplier of paints and coatings), and ITW's industrial peer 3M have all talked of rising raw material prices that were greater than anticipated by management going into the third quarter. That's a concern for a manufacturer like ITW, which uses steel, resins, and chemicals in its plants.

A car assembly line using factory robots.

Image source: Getty Images.

In addition, the supply chain issues related to COVID-19 are holding back swathes of the economy. For example, shortages of semiconductors have caused automakers to cut back production, and lumber shortages have restrained construction activity. The automotive original equipment market (OEM) is a key end market for the company. 

Given ITW's broad exposure to the economy -- shown below in a breakout of its segment revenue in the second quarter -- it's inevitable that it will be negatively impacted.

Illinois Tool Works Segment Second Quarter Revenue
Automotive OEM $707 million
Test & Measurement and Electronics $606 million
Food Equipment $514 million
Polymers & Fluids $466 million
Welding $402 million
Construction Products $518 million
Specialty Products $471 million

Data source: Illinois Tool Works presentations.

So what

The risk of near-term margin pressure is significant, but the real question is whether many issues are likely to prove temporary or lasting? If it's merely a case that demand will be pushed out a quarter or two, then investors might be tempted to buy in on the dip. Moreover, ITW may be able to push through price increases to pass on the cost increases.

However, if these issues persist and lead to demand destruction, then it's likely that analysts will start penciling down earnings assumptions for the company.

Now what

Investors should look out for management's guidance on Q3's earnings presentations, particularly on margin and how lasting these issues could be. On the Q2 earnings call, CEO Scott Santi said the impact on margin from "price/cost" would "likely be modestly higher in Q3 versus Q2 before it starts to go the other way." It might be 2022 before this happens rather than the fourth quarter.