Does ITW's Outlook Reflect an Upbeat Economy?

Jason Stipp: I'm Jason Stipp for Morningstar. Illinois Tool Works raised its second-quarter forecast today. This company, considered a bellwether among industrials. Here to talk about what it might mean for the company and what it could tell us about the economy, is Morningstar's Eric Landry. He is associate director of equity research for industrial companies. Thanks for being here, Eric.

Eric Landry: Hi, Jason.

Stipp: So, ITW raised its second quarter forecast, tell us a little bit about what was behind that? What gave them the confidence to do that?

Landry: Well, we're five-twelfths of the way into the year and they are two-thirds of the way into their second quarter, and obviously, things are going better than they thought. The good thing about covering Illinois Tool Works is, they release their revenues every month, so analysts have a good idea of what's going on. And it is pretty obvious to us, even last month and the month before that, things are going to go up on annual basis for this company, things are really, really hot in Illinois Tool Works right now.

Stipp: So, where are they seeing the most traction? Where are they the seeing hottest sales?

Landry: Well, it's interesting, because they've got 800 different businesses in 57 different countries, and the good thing about Illinois Tool Works is they've very short-cycle businesses, so it doesn't take six months to build one of their products and ship it out. It takes minutes. So, they are very sensitive to the economic changes throughout the world. And in addition to that, they've got several early-cycle businesses like auto, general industrial, and res[idential] construction. So, they are feeling very strong momentum yet in auto and general industrial, res construction as well.

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Stipp: Now, this company, obviously, they are seeing some more optimism. To what extent – this company is considered a bellwether – to what extent might this be company-specific, or are you starting to see other industrial companies getting results that were better than they expected? Might we see that this is a broader trend or is it more ITW?

Landry: Right now, I think, it's safe to say that the industrial space worldwide is one of the hotter spaces right now, but I want to warn you, there are maybe some signs on the horizon that things may slow down at some point. Some of the leading indicators we look at, some of the indexes we look at, for instance, the prices of industrial materials are easing a little bit right now, there is some business cycle forecasting data that we look at, that is easing right now.

So, things are very, very strong right now through May, and we anticipate them being strong for a while, but there are some things in the future that give us a little bit of pause. And to be honest, that's to be expected. You can't grow that strongly forever.

Stipp: Sure. Now, I'm going to ask you to put on your economist hat, just for a moment here. I hope it fits okay.

Landry: I was going to say, I am not sure how well it fits.

Stipp: Now, you mentioned a little bit before about ITW's – how they are sensitive and how they are sensitive to the cycle. So, the fact that they're doing well now, what might that tell us about where we are in the economy, if their businesses are doing well, in the recovery?

Landry: Well, going back to what I said before, if you look at their auto business in particular, that bottomed about a month or two before industrial production. So the economy, if you let me wear my hat, even though probably it doesn't fit very well, the economy tends to go in cycles, right. Consumer spending is the driver. It's the big part of the economy, and then as inventories fill, industrial production is needed to fill those inventories, and then plants wear out, capital spending is the rear of that cycle.

So consumer spending started to turn last year, industrial production shortly thereafter, and now we are getting the capital spending on the back end. So I think the leading indicators may be showing a little bit of weakness right now, but the back end of that, which Illinois Tool Works does has some exposure to, although less, is still sort of in an upswing. There is still momentum in the back end of the cycle.

Stipp: Okay. Last question for you: You mentioned earlier that ITW has a lot of exposure globally and I want to ask you a question about Europe, because I do have pretty substantial amount of business in Europe, if I understand correctly.

Obviously, a lot of concerns about Europe, about the austerity measures some of those countries may have to take. What does it say or what are they saying about their Europe business, or is there anything we can infer about Europe given that they have raised this forecast?

Landry: Okay. Roughly 20% of their business in inside the eurozone, countries that use the euro currency--25%, if you include the U.K. As of right now, it does not appear from the outside that there is any effect on Illinois Tool Works' business right now, but that's really not saying much, because the crisis more or less erupted publicly in the early part of May, and it takes a while with order rates and whatnot for virtually all businesses for that to filter through.

Another data point is not specific to Illinois Tool Works is, China had record amounts of outboard containers in May and they specifically said in the release that, we haven't seen anything from Europe yet, but that doesn't mean that something will not happen in the future. So, it could happen, we could see some slowness here in Europe, but to be fair, there are not a lot of companies who have baked in robust growth from Europe in their forecast. It just hasn't been the case.

Stipp: Not expecting it anyway.

Landry: No.

Stipp: Okay. Thanks so much for joining me, Eric, and for wearing your hats.

Landry: Thanks.

Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.