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The markets had already been exhibiting extra consolation with the outlook for industrials going into the fourth quarter, and the mix of usually higher fourth quarter outcomes and benign steering for 2023 has undoubtedly helped the sector, together with ITT (NYSE:ITT), which has risen about 20% since my final replace, outperforming the commercial house by a cushty margin.
I’d name ITT’s valuation extra “good” than “nice”, however I like the corporate’s mixture of short-cycle and long-cycle enterprise, to not point out its robust share-growing brake enterprise (Movement Applied sciences) and its longer-term alternatives in connectors for aerospace and EV markets. There’s additionally a self-help tailwind right here that will nonetheless not be totally mirrored in expectations or valuation. Mid-single-digit income development with free money circulate margin leverage can assist a excessive single-digit annualized return right here, and this isn’t a nasty choice in an industrial house that has gotten pricier comparatively shortly.
A Fourth Quarter With Little To Complain About
I can quibble with a number of factors in ITT’s fourth quarter, together with margin weak spot in Movement Tech and extra reliance on a decrease tax charge to drive the bottom-line EPS beat, however on the entire this was a really stable quarter. Higher nonetheless, preliminary steering for 2023 actually didn’t spring plenty of surprises.
Income rose 17% in natural phrases, one of many strongest performances within the industrial group, although solely modestly above sell-side expectations. Income was pushed by the Industrial Course of enterprise, which grew 27% on 16% development within the short-cycle enterprise and 74% development within the longer-cycle initiatives enterprise. Movement Tech grew 12%, with 12% development in Friction (effectively forward of low single-digit auto manufacturing) and 10% development in rail. The Join & Management (or CCT) enterprise grew 16%, with robust 26% development within the aerospace enterprise.
Gross margin declined 60bp yoy, however did enhance 120bp qoq, to 32.1%, with ITT nonetheless seeing pressures from commodity and labor prices, however seeing some advantages from pricing and effectivity offsets. Working earnings rose 18%, with margin up 80bp to 17.6%, whereas section income rose 16%, with margin up 40bp to 18.6%. Phase income beat sell-side expectations by about $0.02/share.
By section, Industrial Course of reported 88% revenue development, with a large margin enchancment (up 710bp to 22.9%), whereas Movement Tech went the opposite means with a 24% revenue decline (and margin down 500bp to 14.7%). CCT income rose 18%, with margin up 80bp to 19.2%.
Wholesome Tendencies, However A Slower Second Half Looms
Industrial Course of carried out effectively this quarter relative to its peer group, and as I had talked about in prior articles, the corporate’s publicity to longer-cycle initiatives enterprise got here by means of in an even bigger means, with the corporate benefiting from its higher publicity to markets like chemical substances, oil/gasoline and mining. friends, Crane (CR) noticed 8% development in its Course of Circulation enterprise, whereas Dover’s (DOV) 4% decline in Pumps and Processing was pushed by weaker biopharma. IDEX (IEX) posted 9% development in Fluid & Metering, whereas Pentair (PNR) posted 11% development in Industrial & Circulation Applied sciences. Flowserve (FLS), which additionally has significant vitality publicity, preannounced 13% income development for the quarter.
Within the CCT enterprise, it’s more durable to benchmark ITT, however Eaton’s (ETN) Aerospace enterprise (which incorporates connectors) grew 11%, whereas TE Connectivity (TEL) introduced 14% development in its Transportation enterprise and seven% in Industrial (probably the most comparable components to ITT’s section).
ITT additionally did effectively with respect to order circulate and bookings. Whereas orders have been far more blended amongst industrials, ITT’s <1% sequential decline wasn’t dangerous. The backlog rose 22% 12 months over 12 months, giving the corporate fairly good visibility on at the very least the primary half of the 12 months, and whereas the IP book-to-bill ratio did fall beneath 1.0 (from 1.09 in Q3’22), a drop to 0.97 isn’t horrible.
Administration was fairly express in its name for deceleration within the second half of the 12 months, with short-cycle industrial markets in Industrial Course of and CCT more likely to meaningfully gradual from right here. Longer-cycle companies are holding up higher, although, significantly LNG and clear vitality within the IP section, and ITT does anticipate low double-digit development right here for 2023. In CCT, whereas aerospace is rising strongly and the enterprise is leveraging rising EV manufacturing, weaker auto and protection markets will seemingly restrict development to the mid-single-digits.
I consider administration’s steering for mid-single-digit development in Movement Tech may show conservative. I anticipate mid-single-digit auto manufacturing development in ’23, with EV manufacturing (the place ITT has bigger share) doubling, and I feel rail shall be comparatively wholesome, even with weaker freight volumes, as passenger rail offsets that to some extent.
The Outlook
ITT clearly isn’t proof against short-cycle weak spot, however the market appears fairly assured now that the cycle will backside within the third or fourth quarter (of 2023) and that the lows shall be fairly shallow. Higher nonetheless, end-markets like chemical substances, oil/gasoline, and mining stay wholesome and I’m not too involved a few sharp slowdown in 2024.
I additionally like longer-term alternatives right here. ITT has good leverage to the aerospace restoration cycle by means of its connectors enterprise, in addition to some leverage to automobile electrification with its rising EV connectors enterprise. EV manufacturing can also be a driver for Movement Tech, as the corporate has been profitable extra share on new EV launches (triple its lagging share in standard automobiles). Public funding for passenger rail is fairly robust world wide and ITT has longer-term publicity to scrub vitality (LNG, hydrogen, et al) and electrification (connectors), in addition to semiconductor quantity development (IP pumps and valves).
I additionally see margin leverage alternatives. Administration has accomplished an excellent job of automating manufacturing in Movement Tech and stripping out prices, however hasn’t actually utilized those self same concepts to the opposite segments but. I’m not anticipating radical change, however sufficient to drive ongoing enchancment in free money circulate margins.
I’m anticipating long-term core income development within the mid-single-digits (round 5%), with FCF margin enchancment towards the mid-teens driving adjusted development of round 8%.
Discounted money circulate provides me a near-term truthful worth within the mid-$90’s, whereas a margin/returns-driven EV/EBTIDA strategy provides me a 13x ahead a number of and a good worth near $100.
The Backside Line
I underestimated the Road’s willingness to look previous short-cycle slowdowns, however I don’t suppose the valuation right here is as stretched as it’s for another industrial names. ITT isn’t flashy, however administration is getting the job accomplished and I see share positive factors throughout many components of the enterprise. Aside from a normal concern that the commercial rally could have overshot the mark, it is a title I like as a longer-term holding.
