ILLINOIS TOOL WORKS INC. APRIL 23, 2013 Kaushik Andra, Dan Ballantine, & Keaton J. Cervantes Agenda Introduction Macroeconomic Outlook Industry Overview Company Overview Financial Analysis Valuation Recommendation Illinois Tool Works Inc. Founded in 1912, headquartered in Glenview, Illinois Approximately 60,000 employees Manufacturer of industrial products and equipment across 40 different operating segments with operations in 58 countries Decentralized management structure: contains 8 separate business segments that operate independently Currently listed on RCMP Watch List Last reviewed in April 2005 Source: Illinois Tool Works 2012 10-K Macroeconomic Outlook Industry trend to pursue “Southern Strategy” in the United States Moving operations to right-to-work states United States becoming more competitive globally Decrease in energy and input costs Foreign worker compensation rising, while US wages are stagnant Source: The Wall Street Journal Macroeconomic Outlook Improving industrial output in the United States Industrial production nearing 2007-2008 levels Source: The Wall Street Journal Macroeconomic Outlook After strong increase, shipments abroad are decreasing Source: The Wall Street Journal Global Industrial Machinery Overview Engine, Turbine, and Related is the largest segment of the global industrial machinery, accounting for 36.5% of total revenue Asia-Pacific accounts for 36.8% of total revenue Mitsubishi Heavy is largest player in the industry, generating 6.5% of market value Source: MarketLine Industry Projection Source: MarketLine Industry Forces Analysis Bargaining Power of Buyers: Moderate Low switching costs, but typically buyers opting for machinery best suited to their needs Bargaining Power of Suppliers: Low Commodity inputs with a large number of industry suppliers Threat of New Entrants: Low Highly capital intensive industry Requires high amounts of specific knowledge Threat of Substitutes: Moderate Machines expected to work in heavy duty environment Degree of Rivalry: High 4 largest players only own 14% of total market share Source: MarketLine Company Overview Source: Illinois Tool Works 2012 Annual Report Company Overview Source: Illinois Tool Works 2012 10-K Current Financial Position Source: Illinois Tool Works 2012 Annual Report Financial Highlights Source: Illinois Tool Works 2012 10-K Business Risks Exchange Rates Ballooning pension costs Low employee morale Divestiture Failures Economic downturn globally Failure to realize 80/20 SWOT Analysis Strengths Weaknesses Opportunities Threats • Globally diversified revenue base • Strong dividend history • Multiple end markets and product groups • High number of operating segments and product lines • Unproven track record of management team • Very uncertain future due to current strategy • Divest undesirable business segments to improve margins • Efficient operations once 80/20 strategy is realized • Sensitive to a variety of macroeconomic factors • Exposure to currency risk • High industry competition Strategy 80/20 plan Focus on the 20% of business that is responsible for 80% of revenue Large divestiture planned ahead Reduce business from 800 to 120 business units Restructure or end industrial packaging segment Currently looking at alternatives Using more discipline when deploying capital in the future Source: Illinois Tool Works Q4 2012 Earnings Presentation, Illinois Tool Works Barclays Investor Conference Management Outlook Anticipated increase of revenues in 2013 by 3-5% Anticipated 2013 operating margin of 16.5-16.9% Focus on executing enterprise strategy of simplifying the business Improve operating margins to 20% by 2017 Increase future dividends and share buybacks Looking to divest up to 25% of its remaining revenue base Source: Illinois Tool Works Q4 2012 Earnings Presentation Recent News Former CEO David Speer passed away in 2012 New CEO named in November 2012 Sold 51% stake in Decorative Surfaces business unit in August 2012 Announced new strategy in August 2012 Q4 2012: Revenues down 2.3% from Q4 2011, operating income down 5.9% Source: Illinois Tool Works 2012 Annual Report, Q4 2012 Earnings Presentation Current Stock Information Metric Value Current Stock Price $60.50 Trailing P/E 9.98 Forward P/E 14.21 Dividend Yield 2.51% Market Cap ($ millions) $27,312 Source: Capital IQ, Yahoo Finance Financial Analysis Current Ratio Quick Ratio Cash Ratio Gross Profit Margin Operating Profit Margin Net Margin ROA ROE (Book Value) Debt/Assets Debt/Equity Interest Coverage Liquidity Ratios 2008 2009 1.21 2.00 0.84 1.36 0.15 0.47 2010 1.93 1.37 0.38 2011 2.30 1.52 0.40 2012 3.00 1.63 1.05 Profitability Ratios 2008 2009 34.58% 34.10% 14.63% 9.99% 8.88% 6.82% 9.88% 6.05% 17.86% 11.49% 2010 35.15% 14.62% 9.75% 9.30% 16.52% 2011 35.24% 15.35% 11.64% 12.10% 21.33% 2012 36.09% 15.88% 16.01% 15.39% 27.86% Solvency Ratios 2008 2009 0.24 0.19 0.48 0.35 16.19 8.41 2010 0.17 0.30 12.88 2011 0.22 0.40 14.22 2012 0.26 0.48 13.30 Financial Analysis Accounts Receivable Turnover Days Sales Outstanding Accounts Payable Turnover Days Payables Fixed Asset Turnover Total Asset Turnover Tax Burden Interest Burden Operating Profit Margin Asset Turnover Leverage ROE Activity Ratios 2008 2009 6.40 5.64 57.01 64.67 14.95 13.73 24.41 26.58 8.22 6.76 1.11 0.89 2010 5.96 61.20 13.85 26.36 7.41 0.95 DuPont Analysis 2008 2009 64.60% 78.02% 94.01% 87.58% 14.63% 9.99% 112.41% 86.29% 1.99 1.82 19.82% 10.74% 2010 71.95% 92.68% 14.62% 94.87% 1.73 16.02% 2011 6.47 56.40 15.87 22.99 8.79 1.04 2012 6.45 56.62 16.69 21.87 8.92 0.96 2011 2012 79.87% 79.66% 94.95% 126.55% 15.35% 15.88% 98.90% 92.83% 1.79 1.83 20.64% 27.15% Comparable Companies Company Revenues ($ millions) Market Cap ($ millions) Operating Margin Cummins Inc. $17,334 $19,843 11.2% Danaher Corp. $18,389 $43,324 17.6% Honeywell International Inc. $37,686 $61,088 11.4% Ingersoll-Rand Plc $14,035 $18,406 10.9% Lincoln Electric Holdings Inc. $2,853 $3,960 13.1% Parker-Hannifin Corporation $13,086 $14,285 11.5% Stanley Black & Decker $10,191 $15,196 11.2% Illinois Tool Works Inc. $17,924 $29,592 15.9% Source: Capital IQ Stock Performance Source: Yahoo Finance Comparable Company Analysis Target Company Illinois Tool Works Inc. Ticker Symbol (Exchange) ITW (NYSE) Comparable Companies Cummins Inc. Danaher Corp. Honeywell International Inc. Ingersoll-Rand Plc Lincoln Electric Holdings Inc. Parker-Hannifin Corporation Stanley Black & Decker CMI (NYSE) DHR (NYSE) HON (NYSE) IR (NYSE) LECO (NASDAQ) PH (NYSE) SWK (NYSE) Comparable Statistics High Median Low Mean Price/Book Forward Forward Value TEV/Sales TEV/EBITDA Forward P/E 9.90x 1.69x 8.40x 14.21 3.50x NM NM NM 3.90x 19.30x NM 1.16x 2.25x 1.53x 1.26x 1.33x 1.07x 1.37x 7.60x 10.20x 8.20x 9.00x 8.60x 7.40x 8.20x 12.20 16.88 14.59 14.89 15.27 12.12 13.89 19.30x 3.90x 3.50x 8.90x 2.25x 1.33x 1.07x 1.42x 10.20x 8.20x 7.40x 8.46x 16.88 14.59 12.12 14.26 Source: Capital IQ Comparable Company Analysis Multiple Price/Book Value Forward TEV/Sales Forward TEV/EBITDA Forward P/E Low $ $ $ $ Multiple Price/Book Value Forward TEV/Sales Forward TEV/EBITDA Forward P/E ITW Implied Share Price 21.32 36.53 52.99 51.60 Implied ITW Share Price Median High $ 23.75 $ 117.54 $ 46.63 $ 82.37 $ 59.26 $ 74.95 $ 62.12 $ 71.87 Weight 0% 30% 30% 40% Mean $ $ $ $ Implied ITW Share Price $ 54.20 $ 50.29 $ 61.28 $ 60.73 $ 57.76 Source: Capital IQ 54.20 50.29 61.28 60.73 Discount Rate CAPM Risk-Free Rate Market Risk Premium 5-Year Beta CAPM Cost of Equity 1.70% 6.00% 0.80 6.47% Annual Realized Returns Year Return 2012 21.46% 2011 1.99% 2010 73.07% 2009 37.41% Total Realized Return 114.40% Arithmetic Average Annual Return Geometric Average Annual Return 33.48% 16.48% Source: Yahoo Finance DCF Analysis Weighted Average Cost of Capital Share Price Shares Outstanding (millions) Market Value of Equity $ 60.50 451.44 $ 27,312.12 Debt $ 5,048.00 Percent Equity Weight Percent Debt Weight 84.40% 15.60% Cost of Debt Cost of Equity CAPM Cost of Equity ITW Realized Return Cost of Equity 4.23% Tax Rate WACC 6.47% 16.48% 15.48% 32.0% 13.51% 10.00% 90.00% Cost of Equity Weightings DCF Analysis Illinois Tool Works Inc. Discounted Cash Flow Analysis ($ millions) 2013E Net Income Amortization & Depreciation Capital Expenditures Changes in Net Working Capital Less Increases in A/R Less Increase in Inventories Plus Increases in A/P Free Cash Flow Present Value of FCF Discount Rate 2015E 2016E 2017E 2,176 652 (380) 2,311 651 (380) 2,354 662 (385) 2,380 665 (385) 2,404 667 (390) 118 11 24 2,601 2,292 (22) (82) 20 2,499 1,940 20 (10) 4 2,646 1,809 35 (61) 3 2,637 1,588 37 (6) 3 2,715 1,440 Terminal Value 26,599 14,114 13.51% Calculation of Implied Share Price Implied Enterprise Value $ 23,183 Less Debt $ (5,048) Plus Cash $ 2,779 Implied Market Cap $ 20,914 Implied Share Price 2014E $ 46.33 Terminal Value Terminal Growth Rate 3.00% Decision Drivers Strengths: Improved operating margins Geographically diversified revenue base GICS diversification Strong dividend history Concerns: Management’s ability to execute restructuring plan Stagnating sales growth in key segments Exposure to a number of global macro factors Recommendation Valuation Summary Current Stock Price: $60.78 per share Comparable Companies Valuation: $57.76 per share DCF Valuation: $46.33 per share Recommendation: WATCH LIST Place on RCMP Watch List Consider reviewing again in 18-36 months after divestiture process is more complete