ITT Continues Strong Performance Post-Pandemic, Now Adding Acquired Growth

seekingalpha05-09

ITT Inc. has been a steady stock market performer and is expected to continue growing through organic growth and mergers and acquisitions.The company is focused on improving its margins through ...

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(NYSE:ITT) has been a stock market star for the past year and a steady performer over most of the past five years: Data by YCharts If management can deliver on its goals, those gains will likely keep coming in my view. In addition to organic growth, ITT is also ramping up for mergers and acquisitions [M&A] growth. Three companies have been acquired in the past two years, and it still has $2 billion available for others. In addition, it continues to improve its margins by improving its manufacturing processes and by investing in research and development [R&D]. I expect it to grow by about 12.5% in the next 12 months, increase its dividend, and rate it a Buy. About ITT Founded in 1920 as the International Telephone & Telegraph company, it became a famous conglomerate in the 1960s and 70s. During those 17 years, it bought more than 350 companies, and then later shed most of them. In 1995 it split into three separate and independent companies. After another three-way split, the modern ITT Inc. emerged in 2016, one that would be a global, multi-industrial manufacturer of highly engineered critical components and customized technology solutions. It is once again a firm with three parts or segments:  Motion Technologies, or MT, responsible for 44% of 2023 revenues. Industrial Process, IP, which produced 34% of last year’s revenue. Connect & Control Technologies, CCT; it generated 22% of revenue in 2023.  As a whole, the company serves mainly the transportation, industrial, and energy markets. And as it explained in the 10-K for 2023, “Our products enable functionality for applications where reliability and performance are critically important to our customers and the users of their products.” MT manufactures brake pads, shock absorbers, and damping technologies for the automotive and rail markets. IP manufactures industrial pumps, valves, and monitoring and control systems. It provides aftermarket services for the energy, chemical, petrochemical, pharmaceutical, and other industries. CCT designs and manufactures harsh-environment connectors and critical energy absorption and flow control components. Its products mainly go to the aerospace, defense, and industrial markets. ITT operates internationally:  North America: 42% of 2023 revenue. Europe: 32% of 2023 revenue. Asia: 17% of 2023 revenue. Other: 9% of 2023 revenue.  The firm released its Q1-2024 earnings results on May 2, 2024. Highlights included:  Revenue grew 14%, exceeding $900 million, because of higher volume in all segments. The operating margin increased to 16.4%, from 15.6% in Q1-2023. EPS grew by 12%, or 21% on an adjusted basis, due to higher sales volume and enhanced productivity. It was also able in increase its guidance for the remainder of this year.  It closed at $134.63 on May 7, 2024, with a market cap of $11.08 billion. Competition and competitive advantages ITT operates through three segments and multiple product lines within each segment, meaning it faces a wide range of competitors. It does not list rivals in its 10-K. In the Motion Technology segment, the company reported that customer intimacy, price, technical expertise, and product performance are key drivers. The markets for Industrial Process are highly competitive and fragmented. Customer decisions usually come down to price, lead time, on-time performance, and other lesser factors. Connect & Control Technologies competes in highly fragmented industries, and key criteria are quality, price, lead time, performance, and more. SeekingAlpha lists several peers and competitors for comparison purposes. They are Trinity Industries, Inc. (TRN), The Greenbrier Companies, Inc. (GBX), REV Group, Inc. (REVG), Blue Bird Corporation (BLBD), Terex Corporation (TEX), and Wabash National Corporation (WNC). It said in the 10-K that research and development is critical and focused on “developing competitive solutions to address clear needs in the market segments we serve.” More specifically, R&D provides highly engineered solutions, including solutions to fit its customers applications. The company also pointed out what it calls its “highly customized application engineering, proprietary rights, knowledge capabilities, and brand recognition” as competitive edges. In other words, products that cannot be matched easily by competitors. Based on its key margins, it has perhaps a medium moat:  Gross profit margin [TTM]: 33.57% versus 30.89% for the Industrials sector median. EBITDA margin [TTM]: 19.77% compared to 13.61%. Net income margin [TTM]: 12.41% versus 5.81%.  That’s backed up by a return on common equity of 17.33%, which is 40.38% higher than the Industrials median. Similarly, its return on total capital is 11.54%, and that is 59.95% greater than the sector median. Margins While ITT’s margins have been relatively stable and growing over the past five years, the net margin took a journey of its own. As the year markers on the chart suggest, the bottom line took a serious hit because of the pandemic-induced economic slowdown: Data by YCharts Speaking during the first-quarter 2024 earnings call, CEO and President Luca Savi noted improvement in margins across segments. MT’s margin grew to more than 18%, after increasing every quarter in 2023. CCT’s margin also topped 18% and is aiming for 22%. IP grew its margin by 140 basis points to more than 20%. For Q2-2024, management expects a total margin expansion of 50 - 80 basis points, and is optimistic about gains in the second half of the year. Growth The following chart shows the paths of revenue, EBITDA, and net income over the past five years: Data by YCharts During the earnings call, CFO Emmanuel Caprais explained that while ITT traditionally grew organically, it is now planning more merger and acquisitions. In his words, “ Let me start by saying that we will always invest organically given the proven returns and organic growth we can generate. And now we're intensifying our focus on M&A. We expect this will be a significant value-creation driver for ITT”. It has made three significant acquisitions in the past two years:  Svabehoj: $408 million. Micro-Mode: $79 million. Habonim: $140 million.  And, it still has $1.5 to $2.0 billion of acquisition capacity available. In its earnings call presentation for Q1, ITT raised its guidance for 2024 across the board:   ITT 2024 Guidance table (company presentation) Note that it expects adjusted EPS growth of 8% to 13% this year, driven by higher revenue and better margins. The consensus among Wall Street analysts is that ITT’s earnings will come in near the high end of that range:   ITT Analyst Earnings Estimates table (SeekingAlpha ) ITT also offers a growing dividend, that currently yields 0.97%:   ITT Dividend History chart (SeekingAlpha ) The firm has paid a dividend for 27 consecutive years and increased it for 11 consecutive years. The five-year average growth rate has been 16.71%, and the payout ratio is 21.78%. Management and strategy Chief Executive Officer and President Luca Savi served as the company’s chief operating officer, as well as president of Motion Technologies since joining ITT in 2011. Previously, he held senior roles in Italy, China, and the U.S. for a subsidiary of the Fiat Group. Senior Vice President and Chief Financial Officer Emmanuel Caprais joined ITT in 2012. Earlier, he held senior financial positions at Motion Technologies and Industrial Process. According to its 10-K, its strategy is to create long-term shareholder value through four strategic priorities: customer centricity, operational excellence, effective capital deployment, and sustainability and innovation. Much of the strategy’s emphasis is based on its capital allocation priorities, as shown in this slide from the earnings call presentation:   ITT Capital Deployment slide (company presentation) All elements of the framework should drive future growth and shareholder rewards. A couple of them deserve more attention. First, its organic growth initiatives include shop floor automation, productivity, and R&D. These should help the company maintain or reduce its costs and expand its margins. Second, it still has up to $2 billion of capital to apply to merger and acquisitions activity. In the earnings call, CEO Savi reported, “In the past few years, we added experienced deal makers to our leadership team and strengthened our M&A teams in the business.” Third, management reported in the earnings call that any M&A funds not used would be added to the shareholder returns budget. Reducing the share count by about 7%, as reported in the slide above, would push up earnings significantly. Adding more capital for buybacks, as well as continuing to grow the dividend by 16% per year, would also benefit the share price. Valuation The key metrics show that ITT is currently overvalued; this is an excerpt from the company’s valuation page:   ITT Valuation Ratios table (SeekingAlpha ) That comes as no surprise as its stock has risen 60.65% in the past year and 118.24% in the past five years, as we saw in the price chart above. Investors have positive expectations about this stock, and are buying in anticipation of more strong capital gains and total returns. As noted above, 2024 earnings are expected to grow by 12.07%, and by another 12.67% in 2025. Averaging those estimates, we get an increase of 12.37%. Adding 12.37% to the May 7 closing price of $134.63 provides a target price of $151.28. That’s very close to the intrinsic value calculation of $152.40:   ITT Intrinsic Value calculator (OmniCalculator) Data in the intrinsic return calculator are based on the sum of the four earnings results in 2023; expected annual growth rate is the average of the 2024 estimate of 12.07% and 2025’s estimate of 12.67; bond yield is based on the US Corporate AAA rate; and the market price is after the close on May 7. I therefore have a one-year price target of $151.28, expect the dividend to be around 1.0%, and rate ITT a Buy. There have been no other SeekingAlpha ratings in the past 90 days and the Quant system rates it a Hold. Wall Street analysts have an overall rating of Strong Buy, with nine Strong Buys, one Buy, and one Hold. Risk factors ITT is a global company, with 58% of its revenue originating outside North America. That means it has geopolitical and currency exposures that could adversely affect its financial results. That includes everything from tariffs to the strength of the dollar. As a company that plans to put increasing emphasis on mergers and acquisitions, it could pay too much for acquisitions, experience integration problems, or take management’s focus away from key business issues. Many of its end markets are cyclical, including the energy, chemical and mining industries. Collectively, these industries represented 23% of 2023 revenue. More broadly, its business is affected by economic cycles, capital investment, and more. Anti-takeover provisions in ITT’s incorporation articles and bylaws could delay or prevent the company from taking action that shareholders might favor. One such measure allows the board to issue one or more series of preferred shares in response to a threat of a change in control. In addition, institutional investors hold just over 92% of the company’s stock, giving them significant influence on board decisions. Some of those decisions might be against the interests of individual shareholders. Conclusion ITT Inc.’s stock has been a strong performer since coming out the pandemic-induced slowdown of 2020. That will likely continue in coming years, as the company invests in both organic and acquired growth. It also has signaled its intention to keep repurchasing shares and to growing the dividend.  It’s unlikely to repeat the share price performance of the past year, but should still do well, with expectations the price will rise by 12.37% over the next 12 months. 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