Scott Santi is showing he can do more than just cut costs at Illinois Tool Works Inc.
Accelerating revenue growth helped power Glenview, Ill.,-based ITW pass Wall Street earnings expectations for the first quarter. Until now, Santi has relied mostly on cost savings to lift profits and shareholder returns at the sprawling conglomerate, which makes everything from welding tools to auto parts and food-service equipment.
Named CEO in 2012 after the death of predecessor David Speer, Santi took the helm just as ITW launched an aggressive plan to streamline the company. ITW hopes to expand operating profit margins and return on invested capital to 20 percent or better by 2017.
Much of the action last year was on the cost side, as Santi compressed 800 business lines into fewer than 100, and sold off slower-growing, commoditized businesses.
Earlier this year, ITW inked a deal to sell its $2.4 billion industrial packaging group to The Carlyle Group for $3.2 billion. The unit includes strap, stretch and protective plastic products.
Overhead dropped quickly, lifting operating margins to 17.8 percent last year from 16.7 percent in 2012. Shareholders applauded the rapid progress, pushing ITW shares up 38.3 percent last year, easily topping the 29.6 percent gain by the Standard & Poor's 500 Index and even besting the 37.6 percent for the S&P 500 index of industrial stocks.
KICKING THE HABIT
Big questions remained, however, about Santi's ability to rev up revenue. ITW historically relied on acquisitions to boost the top line, buying dozens of companies a year. Buyouts generated about two-thirds of revenue growth, with only a third coming from internal sources.
Santi promised to reverse that ratio as part of a bigger commitment to boost ITW's overall revenue growth to 2 percentage points above overall industrial production growth. Historically the company targeted only a 1 percentage point edge over industrial production.
First-quarter results brought signs of progress toward that goal. Organic revenue grew 3.3 percent, a significant improvement on the 1.2 percent rate ITW reported for 2013.
“Given the skepticism about their ability to grow, this is a step in the right direction,” says analyst Mircea Dobre at Robert W. Baird & Co. in Milwaukee.
Growth was strongest in ITW's automotive sector, where organic revenue rose 13 percent, far outpacing the auto industry's 5 percent rate. ITW said new products played a key role, a sign the company is developing the innovation capabilities needed to drive organic growth.
The auto group includes production of plastic closure systems and tooling.
Cost-cutting, however, is still driving most of the improvement in ITW's operating margins, which expanded by 1.8 percentage points to 18.7 percent in the quarter. Reductions in overhead and other cost savings contributed 1.2 percentage points of the gain, ITW said.
Paring down the company also contributed to the upturn in organic revenue growth. ITW executives told Wall Street analysts on an earnings call April 22 that about 1 point of first-quarter organic growth acceleration resulted from the sale of slower-growing businesses.
According to analyst James Krapfel of Morningstar Inc. in Chicago, this leaves a key question unanswered: “To what extent has the organic revenue growth profile really improved?”
Other concerns on the revenue side include the likelihood that torrid automotive growth will moderate later this year, and a downturn in ITW's welding products business, a major line that has suffered along with its customers in the heavy equipment industry.
Still, Santi voiced confidence in ITW's growth prospects. “We've worked very hard on shaping the portfolio so that we are in a collection of businesses that we have a lot of conviction about their ability to grow at a healthy clip organically,” he told analysts. “This year is a year we expect to turn our attention more to the organic growth agenda.”
Investors have reason to believe Santi. So far, he's done everything he's promised to do and then some. Operating margins are ahead of schedule — ITW raised this year's forecast to the mid-19 percent range, within spitting distance of the 2017 goal. ITW also boosted its full year earnings forecast and said it has accelerated a share repurchase program, which always pleases Wall Street. Shares climbed 51 cents to close at $85.11 yesterday.
Much of the confidence in ITW's outlook stems from the likelihood that cost cuts alone will carry the company to its profitability goal and ensure a steady stream of buybacks. But it's a lot harder to cut costs and produce the long-term revenue growth that will hold investors' interest.
This quarter's results suggest Santi can pull it off.