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Why we still like ITT Corporation, NYSE:ITT

Thu, 08/20/2009 - 7:12am
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ITT

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    We wanted to share with you a recent report from our AFG 50 model portfolio.


    ITT (NYSE: ITT) Investment Summary: ITT reported an 11% decline in Q2 09 adjusted earnings from continuing operations of $196 million, or $1.06 per share, and 9% lower sales of $2.78 billion. The results exceeded analysts’ estimates of $0.80 EPS and $2.7 billion in sales. The earnings outperformance was mostly due to aggressive cost-cutting initiatives within the company’s Fluid Technologies segment and strong demand for high-margin businesses in the Defense Electronics segment.

    ITT is slightly more optimistic about H2 09 within some of its businesses, compared to its rather bleak assessment in the prior quarter’s conference call. Within Fluid Technologies, the residential water business has shown signs of stability. However, offsetting the improvement in residential, the commercial water business continued to deteriorate faster than expected. ITT continues to realign businesses within Fluid Technologies to look for cost savings. The Motion & Flow Control segment will benefit from new business won for major automotive companies such as BMW, Daimler, and the Ford Taurus program. Working to somewhat offset the improvement in automotive is the continued pressure in the aerospace market, including the recent Boeing 787 delay. The recurring bright spot in ITT’s business continues to be its Defense Electronics segment, as orders increased double digits due to global positioning systems (GPS) and environmental satellite programs. Also, the company’s dominant position in CREW jamming systems, night vision goggles, and SINCGARS radios provides recurring sales for highly prized technology utilized in U.S. and international military applications. ITT continues to restructure all three segments and raised the expected 2009 restructuring charge to $80 million, up from the previously guided $65 -$70 million.

    Given the slightly better outlook in ITT’s non-defense segments, management raised its full-year adjusted EPS guidance to $3.50 -$3.70, up from $3.20 -$3.60 previously guided. Total company sales are expected to decline 6% -7%, compared to 2008, slightly better the previous guidance of 6% -9% lower sales. We reiterate our Buy recommendation for ITT and continue to hold it in the AFG 50 Portfolio. Our updated model suggests a target price of $58 or 19% upside. (Please see model ITT 8-17-2009).

    Our updated model reflects a slightly better EBITDA margin projection for 2009 and a modest improvement in sales growth in 2010.All other value drivers remain mostly unchanged.

     

    Not surprisingly, ITT has maintained relatively steady Economic Margins given the strength of its core businesses. ITT has been enhancing core operations mainly by acquiring companies, such as WEDECO AG Water Technology in 2004 and EDO Corporation and International Motion Control, Inc. in 2007. With leading technological advantages, ITT is able to capitalize on many defense areas. Its Fluid Technology business should benefit from positive direction of the demographic, environmental and regulatory environment. ITT has also divested non-strategic assets to more attractively position its product portfolio. Going forward, product line enhancements and strong demand for products used by military forces will continue to drive organic growth for many years to come.

    Mgmt Quality Migration (Current vs 5 Yrs Median)

    •Red represents the current year while black represents a 5-year median.

    Favorable macroeconomic trends in the past several years helped the whole industrial machinery group earn the distinction of dwelling in the upper right management quality quadrant. Last year, the entire group was negatively impacted by the global economic slump, shown visually by a shift to the left in expected Economic Margins. ITT is expected to fare better than its peers with a continued positive EM, although its asset growth was negative last year as a result of the company’s repayment of acquired debt related to a large acquisition in 2007. Going forward, we expect ITT to transition back into the upper right quadrant over the next few years.

    Q2 2009 Highlights

    Earnings:

    Earnings fell 9% to $201 million, or $1.10 per share, compared to $221 million, or $1.19 per share, in the same quarter a year ago. Adjusting to exclude restructuring charges and a tax benefit in both periods, EPS declined 10% to $1.06 from $1.18 a year ago.

    Sales:

    Sales fell 9% to $2.8 billion, compared to $3.1 billion in the same quarter a year ago. Excluding foreign currency affect and contribution from acquisitions, organic sales dropped 5%.

    • The Defense Electronics segment’s sales were flat with the prior year quarter at $1.6 billion. The backlog was flat with last year at $5.2 billion.

    • Fluid Technology segment reported a 15% drop in sales to $869 million. Organic sales declined 7% as foreign currency translation lowered sales by 8%.

    • The Motion & Flow Control segment experienced a 30% sales decline to $308 million. Sales dropped 19% organically as foreign currency caused an 8% decline in sales and divestitures caused sales to be 3% lower.

    Margins:

    • Gross margin: Declined 5 bps to 30.77% compared to 30.82% a year ago.

    • EBITDA margin: Increased by 20 bps to 14.5% from 14.3% a year ago.

    Capital Structure:

    In May, ITT raised $1 billion in long-term senior unsecured notes to refinance its short-term debt. $500 million notes were issued at 4.9% interest rate and the remaining $500 million were at 6.125% interest.

    Outlook

    Q3 2009

    Earnings:

    EPS guidance is $0.80 -$0.90, suggesting a decline between 19% and 28% vs. the year ago quarter.

    FY 2009

    Earnings:

    EPS guidance is $3.50 -$3.70, higher than $3.20 -$3.60 as previously guided. EPS guidance excludes expected restructuring charges.

    Sales:

    Sales are expected to be in the range of $10.8 billion -$11 billion, suggesting a decline of 6% to 7% when compared to 2008.

    Restructuring:

    Expect to spend $80 million on restructuring activity, up from $65 -$70 million previously guided.

    Contract Win:

    On July 9, ITT announced that it was awarded a contract for technical support, enhancements, maintenance and upgrades to the software that supports the SINCGARS radio in the Joint Tactical Radio System (JTRS) program in military platforms. The contract is valued at $22.9 million, with three one-year options that can reach total program value of $62 million.

    If you are a professional money manager and would like to learn how we may be able to help your investment process, click here to learn more about AFG

     

    Our Variables

     

    AFG's Valuation Metric – Measures the percent to target (deviation between a stock’s current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model (modified discounted cash flow model).
     
    Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.
     
    Management Quality – Assesses management’s ability to make wealth creating decisions.

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